LWStock Trading Investing Course

Larry Williams
Stock Trading and

Investing Course
Part 1
A comprensive guide
to buying and selling
the right stocks at
the right time.
Larry Williams Stock Trading & Investing Course
Part 1
Market Timing
Contents
The One Sure Thing of Stock Investing 4

Yet, Market Timing is So Critical 5
The 10 Year Pattern in the United States Stock Market 6
Breaking it Down to Specifics… Taking it Year By Year 9
My Four Year Discovery 25
Dispelling Some Notions 36
The Best of the Best, 1900 to Date 39
Politics… A Special Consideration 39
Fundamentals Matter 47
P/E Formula for Predicted Future Returns 57
Disclaimer 64
© 2015 Larry Williams CTI Publishing. All Rights Reserved.

The Stock Market
... A Long Term
Perspective
I wish someone would have set me down for a “Dutch Uncle” stock market
talk when I began following the markets in 1962. My life would have been
far easier and I’d be a darn site wealthier. So that’s where I am going to begin
with you, a frank, straight from the heart lecture based on my experience and
research.
- Larry Williams
No part of this publication may be reproduced, stored in or introduced into a retrieval system, or
transmitted, in any form or by any means (electronic, mechanical, photocopying, recording, or
otherwise), without the prior written permission of LnL Publishing, LLC and Larry Williams.
The distribution of this manual via the Internet or via any other means without LnL Publishing,
LLC’s and Larry Williams’ permission is illegal and punishable by law.
4 | Larry Williams Stock Trading & Investing Course
The One Sure Thing of Stock Investing

This first lesson of investing may well be the hardest to learn, but the simplest way to state it is just
this:
The long term trend is always up.
Never forget that lesson, and never let anyone steer you off the long term upwards path stock prices
have always been on. Oh, I know full well that stock prices often decline, and may for a year or two,
or three… but eventually they always --- yes always --- make new highs.
The purveyors of pessimism, the Bears, will always be there berating the world, the economy, the
political powers of the day and will scare you out of more profits than you will ever lose from being
long (at least if you follow my advice in this course). The purpose of the Bears is to frighten you
into inaction, to freeze your assets or worse yet, place them in the wrong investment at the wrong
time.
In an article in Forbes Magazine found:
Over the long term, stocks have historically outperformed all other investments.
From 1926 to 2014, the S&P 500 returned an average annual 10.12 percent gain. The second best
performing asset class was Bonds. Long term U.S. Treasury notes returned, on average, 5.5 percent
over the same period. Real estate has also been a good investment, but much of the “gain” is illu-
sory, for the average person has many costs of holding in real property: taxes, interest, insurance, and
upkeep. A stock investor has none of those headaches or costs!
I am talking about the very long term here and will acknowledge over the short term, stocks can be
hazardous to your financial wealth. On October 19, 1987 stocks experienced the worst one-day drop
in stock market history - 22.6 percent. If you had invested in a NASDAQ index fund around the time
of the market’s peak in March 2000, you would have lost three-fourths of your money over the next
three years. I was not invested at that time based on the simple rules I teach.
Danger lurks on Wall Street, that’s for sure. But you have to show up at work to get paid, and you
have to invest with a belief in the future for investments to pay off.
The trend is up and any long term view or position against the trend will punish the
investor.
There have been great times and bad times since 1926, a time frame that covers the two worst crash-
es the market has seen. Yet on balance, there was a 10.12 percent gain available and, as I will show
you, a lot more for the investor that did not get sidetracked and invested correctly.
There are cycles or patterns to the very long term stock market movements that I have learned and
observed in operation that I would like to share with you. There really is more method than madness
to long term stock market movements than you might suspect.
Long term investors can become wealthy in the stock market. In and out traders, “shooters”, and
chasers of hot stocks are destined to lose. The approaches here will help such dreamers, but the sure
thing comes from investing… not trying to hit home runs and get rich quick. Don’t take my word for
this…take the chart of the Dow from 1925-2015.
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Chart 1: Dow Jones Industrial Average Monthly Price Bars 1925 to 2015
What an impressive view of the past and future... contrast this view with what real estate has done!
Chart 2: Home Price Index
Yet, Market Timing is So Critical

It’s typical for brokerage firms and mutual funds to stress that market timing is not important; that
you are in for the long haul so you want to be fully invested all the time. When a traditional broker
is asked about his sell strategy you may hear something like this, right out of a broker’s procedure
manual:
“Don’t you know that with a Buy and Hold strategy for the last 35 years, $1,000 would have become
$11,000? That is a very good 10% annual return. A study our firm did points out that if you were
not in the game, you were out on the side line and missed the 5 best performing days, each year in
the market from 1966 to 2001, then that $1,000 investment shrinks to $150.00. That’s a -5.3% an-
nual return.
It is impossible to time the market. You have to be right twice. First when you decide to exit the
market and second when you re-enter the market. So just sit back and let me worry about your port-
folio. Stay fully invested.”
What he fails to tell you is if you miss the 5 worst days in the stock market during each of those
35 years, the $1,000 becomes $987,000, for a 19.3% annual return. Suffice to say, many studies
now show that missing the worst days is more important than participating in the best days.
That’s something I have always stressed and am willing to do… sit on the sidelines so we don’t
get clobbered as so many have. There is a time to sow and a time to reap for investors as well
as farmers. So, while I am always long term bullish I want to teach you now how to sidestep
major declines while making certain you are long at major buy point.
The 10 Year Pattern in the United States Stock Market
“It’s about time.” My 1978 U.S. Senatorial Slogan!
Edgar Lawrence Smith: The All Time Market Genius

No one has a better track record of predicting the future than the very little known Edgar Lawrence
Smith. Don’t take my word for it, read what super investor Warren Buffet said in 2001:
“And then came along a 1924 book--slim and initially unheralded, but destined to move markets as
never before--written by a man named Edgar Lawrence Smith. The book, called Common Stocks as
Long Term Investments, chronicled a study Smith had done of security price movements in the 56
years ended in 1922.
Smith had started off his study with a hypothesis: Stocks would do better in times of inflation and
bonds would do better in times of deflation. It was a perfectly reasonable hypothesis.
But consider the first words in the book: ‘These studies are the record of a failure--the failure of facts
to sustain a preconceived theory.’ Smith went on: ‘The facts assembled, however, seemed worthy
of further examination. If they would not prove what we had hoped to have them prove, it seemed
desirable to turn them loose and to follow them to whatever end they might lead.’
Now, there was a smart man…” Warren Buffet
Yes, as Warren points out, Smith was not only ahead of his time, but brilliant. Buffet based his
investment philosophy on the kernel of truth Smith set forth in 1922. But Smith went beyond that,
as he also constructed a time line for investing. This was something he called the decennial pattern,
a pattern obtained by averaging stock prices for each year from 1860 to 1938. This was presented in
his 1939 opus “Tides in the Affairs of Men: An Approach to the Appraisal of Economic Change.”
market Timing | 7
Now, old Edgar put forth the view in 1939 that stock prices moved in a certain pattern during each
decade. The basic pattern, he claimed, was for stocks to end a decade, years ending in 9 (like 1929)
with stock market weakness and then see bottoms in years ending in 2 like 1922, 1932, etc.
The Past Is Your Future
Chart 3 shows the pattern on data from 1900 to 2000. We see the pattern has continued.
Chart 3: Dow Jones Industrial Average Decennial Pattern
It is of great interest to me that while Mr. Smith’s work was completed in 1938, we saw declines
around 1959, 1969, 1979, 1989 and of course a bull’s eye in 1999. All clearly foretold by the 1938
writings!
What you see in Chart 4 is the general long term road map I expect the market averages will traverse
every decade.
My long time friend Yale Hirsch (whose son Jeff has slipped into dads’ shoes) Chart 5 in 1969 based
on the work of Edson Gould (another supporter of Smith’s work).
Chart 4: Dow Jones Industrial Average Decennial Pattern
Chart 5: Decennial Pattern
What Yale did was to carry on the averaging of stock prices from 1861 to 1960 with an overlay of
how stocks performed in the next bull markets. As you see in Chart 5, it’s a very good fit. This 10
year pattern is the best general road map you will ever have to help navigate the waves of investor
sentiment and value over the years. It is probably the cause of the 10.5 to 11 year Solar Cycle, for
those wanting a reason why.
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Breaking it Down to Specifics… Taking it Year By Year
The Phenomenal “Five” Years

I have learned a lot about the markets from Yale Hirsch (all he learned from me was how to catch
trout). Yale has also uncovered a second tremendously important point within this overall pattern of
price swings. Yale pointed out in his book “Don’t Sell Stocks on Monday” that the middle year of
this ten-year pattern tends to produce some real rock and roll upside markets.
The following table shows the average gain of each individual year of the decade. We have had 11
decades under our belt to study. What we see is that in 11 out of 11 times, the fifth year in the decade
produced a rally or a market-up move making it the strongest year in the ten-year pattern.
Years ending in eight, showed winners 8 out of 10 occurrences. Years ending in seven and eight also
showed eight out of 11 years of rallies. The poorer performing years were those ending in seven and
those years ending in a 0... just as Smith’s work had suggested.
The Ten-Year Stock Market Cycle: Year in Decade

Decades 1st 2nd 3rd 4th 5th 6th 7th 8th 9th 10th
1881-1890 - - - - 20 9 -7 -2 3 -14
1891-1900 18 1 -20 -3 1 -2 13 19 7 14
1901-1910 16 1 -19 25 16 3 -33 37 14 -12
1911-1920 1 3 -14 -9 32 3 -31 16 13 -24
1921-1930 7 20 -3 19 23 5 26 36 -15 -29
1931-1940 -47 -18 48 -2 39 28 -34 13 0 -12
1941-1950 -15 6 21 14 33 -10 -2 -2 11 20
1951-1960 15 7 -3 39 23 4 -13 33 11 -4
1961-1970 27 -13 18 13 9 -11 17 12 -14 -1
1971-1980 10 12 -19 -32 32 18 -10 2 11 26
1981-1990 -7 13 18 0 26 - - - - -
1991-2000
2001-2010
Up Years 7 8 4 6 11 7 3 8 8 3
Down Years 3 2 6 4 0 3 7 2 2 7
Total %
Change 25% 32% 27% 64% 254% 47% -74% 184% 41% -36%
Based on average December prices
Table 1: Average % Gain in Standard & Poor’s Composite Index of Each Decade
That is well and good, but of greater importance to an investor is not simply if a year was up or
down, but how much money was made in the year.
Without a doubt the fifth year of the decades has been where the bulk of wealth has been made.
Yale’s work showed a total gain of 254 percent in all of these five years, making it heads and shoul-
ders above even the second-place eight years that came in with a 164 percent gain.
What Yale had no way of knowing is what would happen in the 1990’s or 2000’s. Those years were
all out of sample. It was unknown at that time how 1995 would perform, would it follow this tra-
dition? Or would it break the consecutive string of the 11 winning years ending in a 5? And how
about that eighth-year in the pattern? Would it also produce gains similar to those as it had in the
past?
From 1881 through 1991, years ending in five produced an average gain of 31.3 percent. Years end-
ing in an eight produced an average gain of 14.9 percent.
1995 produced a spectacular gain of 33.5 percent by the Dow Jones Industrial Average. 1998 pro-
duced a gain of 14.9 percent in the average, making these the two best-performing years of the 1990
decade! Just think, the gains of 1995 and 1998 were right on schedule with the expectation for a
forecast made generations earlier! Keep in mind that forecast was essentially locked into iron shack-
les in 1960. Yet it was able to correctly point investors to the two most profitable years in the 1990-
2000 bull market. Perhaps, just perhaps, the stock market is a little bit easier than you ever thought.
I suggest you take a great deal of time to restudy and view the longer-term charts, so you can get a
sense of this phenomenon, perhaps pick up the cadence at which the market moves. For a real lesson,
let’s take a look at all years ending in 5 from 1905 forward.
Chart 6: Dow Jones 1935

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Are you a believer year? I’m a huge fan of the five year bullishness. Our next chart of stock prices
from 1795 to 1895 shows the same pattern!
Chart 14: Dow Jones Industrial Average 5 Year Pattern Based on 1795 - 1895 Data
To that extent the data from 1795 to 1895 is helpful, as it suggests we should be looking for a low in
April or June of 5 years… that was the typical seasonal pattern a few hundred years ago.
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“DEJAVU ALL OVER AGAIN --- It’s probably a good thing for us to revisit this pattern to better
understand 2005. While the 100 years from 1795 to 1895 shows early year weakness, the data from
1905 for the next 100 years is quite similar and more so in this one important respect:
The bulk of all ‘5’ year gains came from the middle of June into the end of the year.
In other words there is a ‘sweet spot’ to these years… a time when the bullish ball gets the most pop
off the racket and that time is now upon us. Only one 5 year in the last 12 such years has the market
not exploded higher. That “poor performer” was 1975; but prices were still substantially higher 6
months later.
The “Sure Thing Seven” Years

Clearly, some years are better for buying than others. The focus of my work has been to ferret out
the best years, the most explosive years… the ones with the greatest odds of having significant
upside action. Sure you can buy and hold for twenty years and make money… no brilliance there.
What I want is to make my wagers when the dice are loaded.
My insight and addition to our knowledge of the ten-year pattern is that there is yet one more place
to look to buy stocks. Is it just coincidence that the 1960 road map, which suggested a major buy
point at the end of years ending in seven, scored with big wins in 1977, 1987 and 1997? Each of
those years provided investors with excellent end of a year buy points. I suspect not, I suspect there
is something going on in the general economy, business cycle… call it what you may, because this
pattern is simply repeated too many times, too often, to be just some random fluctuation of numbers.
It appears God may not play dice with stock market numbers.
It’s now time for you to study the Axe-Houghton Index of stock prices from 1854 forward (Charts
15 & 16). The same phenomena can be found to have occurred. Late in 1857 stocks bottomed, then
almost doubled in price. The fall of 1867 produced an equally spectacular rally that continued all the
way to the 1869 market high.
Wouldn’t you know it, when 1877 rolled around, stocks again bottomed about midyear. Then later in
1877 a two-year bull market started steam-rolling. That takes us to 1887 when again, in the fall of
the year, stock prices bottomed and then began a two and half-year bull move.
1897 saw pretty much the same thing. Prices bottomed earlier in the year. We had a summer run up,
a pull back in the fall of the year (the 7 year buy zone), and then stocks took off on another two-year
bull market.
Chart 15: Axe-Houghton Index of Stocks 1854 - 1902
This becomes almost uncanny, especially when one looks at the 1907 bottom. It came late in the
year, about December and began another two-year bull market. 1917 was almost a replica of 1907;
again prices got hammered down into a low at the end of that year before they took off on another
two-year bull market.
Then there’s 1927. What more can one say? There appears to be no major low here. Prices went
straight up... but if you look closely you will see that in the fall of 1927 prices stabilized briefly, pull-
ing back off the year’s high before another two-year bull market surged into the 1929 top.
Well, that brings us to 1937, a year stocks declined with a vengeance, bottoming in the first-quarter
1938 and another two-year bull market began. So this time the seven-year phenomenon was off by
about three months. Big deal, that’s close enough for government work. In fact that’s pretty much
what happened ten years later in 1947; the average moved sideways for most of the year, came down
in the fall of ’47, and bottomed in mid-February of 1948. There was no two-year bull market fol-
lowing, prices simply had a huge run-up in 1948.
In 1957 stocks followed the model perfectly. There had been a run-up in the first part of ‘57. Price
then crashed, coming into an October low or a bottom, to begin one more substantial up move in the
American stock market. This was in perfect harmony with the seven-year price pattern.
Ten years later yet one more wonderful buy point was presented. Stocks rallied during the first
of 1967, then took a tumble into the fall of that year. The market bottomed in February 1968 and
started, not a two-year bull market but, a strong rally for the rest of 1968. Clearly, history shows
there was a very nice buy point in late 1967 and early 1968.
Does it appear to you there is something to this phenomenon? It does to me. Is there an explana-
market Timing | 17
tion for it? Frankly I can come up with some explanations, but I’m not certain they prove a point
anymore convincingly than a study of five years and seven years, as well as the two and three years
in terms of historical precedent. After all “the document speaks for itself.” The charts don’t lie. It
is there, and it’s up for us to learn how to exploit the past so our investments might be better in the
future.
Chart 16: Axe-Houghton Index of Stocks 1900 - 1935
There has been a very distinct price pattern for years ending in seven going back now for 120 years
this pattern has persisted setting up some marvelous selling opportunities, like 1987, 2007, 1977
or 1937. In instance after instance we have seen substantial selloffs at this time. Obviously to me as
a long-term investor this means that I want to lighten up on my portfolio somewhere around the
middle of such years this cyclical pattern has just been far too strong to not honor.
The 7 year pattern calls for early in the year strength, often quite spectacular, with a bear raid on
stocks kicking off in late July.
Chart 17: 7th Year Pattern of Dow Jones Industrial Average
You will see this on the following chart starting with 1927 and moving forward.
Chart 18: 7th Year Pattern of Dow Jones Industrial Average 1927
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No one knows if this is the shape of things to come for 2017 it may not be, but as I see it, the president
of selloffs starting in the latter part of such years is just too strong. So I will be on the sidelines
somewhere in June July of that year.
market Timing | 23
Of course what we’re talking about here is just timing. We still have to get into the issue of selec-
tion; what stocks to buy. However, many investors have a pretty good idea of the companies they
want to purchase; they just don’t know the right time to do so. Buying or selling them at the right
time does make a huge difference. As an example, on balance, if you purchased stocks at the start the
of sixth year you had to wait until the eighth year to make money. Another example, on balance, if
you purchased stocks in the years ending in nine, you had to wait almost five years before your aver-
age stock showed a profit. So, timing your entries and exits in the stock market is critical. It makes
a huge difference. I believe one way to gain an advantage in this business of speculation is to follow
the ten-year price pattern.
It would seem unreasonable to expect stock prices to follow some mythical and perhaps even mysti-
cal road map printed in the 1960’s on out into eternity.
Yet, that is precisely what has taken place, by and large. Which raises the question, will markets of
this decade continue to follow this road map? Honestly nobody knows for sure, that‘s a judgment
call that will not be answered until the time period is over. However, we can look at what has trans-
pired and watch the remaining years to see how closely this pattern is repeated. Frankly, I suspect
it will be repeated, and closer than you might imagine. The acid test was that 2005 was another up
year, and 2007 took a mid year hit. The overall price pattern has generally followed the ten-year
road map. I think this gives even more validity to this concept and should give investors more cre-
dence and more confidence in using this is as a general guideline of investment activity for years, or
perhaps decades, to come.
What I hope I have accomplished is to show you that the market does have repetitive tendencies to
how it unfolds over the years. The framework of reference does indeed seem to be the decennial pat-
tern. Within that framework there are particular times that one should look for optimal buy points.
The first would be years ending in 2’s and 3’s... that are followed by the incredibly strong 5 years.
The next opportunity to look for a buy point is in the late fall of years ending in seven.
Finally, a long-term investor should never forget that the majority of major market highs have come
in years ending in nine and zero, such as 1929, 1939, 1969, and 1999.
I look upon this decennial pattern as the most logical road map that prices will follow. I certainly do
not expect prices to mock this price pattern precisely each year or each decade. It wouldn’t be any
fun to trade stocks if it were that easy. But we are given excellent guidelines here of which turns in
the road to take, as well as when to take them.
The Straight Eight Factor
While I have pointed out a seven-year low-point phenomenon, there’s another part to the decennial
cycle or pattern I would like to share with you.
Simply stated, it’s this; years ending in an eight have shown a unique ability to start major market
rallies. Usually this begins in the first three months of that year. It is almost as though the seven-year
low-point, such as the one presented to investors in 1987, gets so oversold, or perhaps undervalued,
that prices usually have easy sailing for the next year, the one ending in an eight.
Again, I’m not certain why this phenomenon exists. Some say it’s due to sun spots, some say baro-
metric pressure, and I’d say Federal Reserve activity. While there’s plenty of room for discussion
about the cause of this phenomenon, there can be no discussion about whether it exists or not.
In researching prices back to 1850 I noted that there have been 15 times where we have seen this
pattern appear. That means we have 150 years experience with this intriguing eight year opportunity,
which I think you’ll find presents investors with a superb buying opportunity.
Some of the most exponential moves in the entire history of the stock market are those which started
with years ending in an eight, such as 1888, 1928, 1938 and no one could ever forget 1998. That
year was so strong everybody began buying every type of stock, whether good or bad, just before the
market debacle… which came to light in 1999 and 2000, just when it should have!
The only year that did not produce a substantial bull market which ended with an eight was 1948.
This was not a bad time to buy stocks, just not a phenomenal one. There was a large rally off the
March lows of that year. The March low in the Dow Jones was 165, serving as the base for a rally
up to the 195 for an 18 % gain during the year, which closed for the year at about 177.
The strong point of these eight-year patterns is that it appears one should buy about the eighth week
of the eight year. That sure worked wonders in 1928, 1938, 1948, 1958 and so on. Had you waited
until the eighth week of 1978 you would have purchased one week from the ultimate low point for
the year, while in 1988 and 1998 the low came just a few weeks earlier in January.
The study of this eight year pattern should certainly focus our attention, to be alert, for an early buy
point in the years ending with eight. Accordingly, a wise investor should pay particular attention to
2008, 2018, and yes we can even forecast out to 2028... when I expect the market to have significant
upside performance.
Table 2 below presents the results of buying in March of the years ending in an eight, starting in
1878 through 1998. The exit is on the close of last trading day in December. While this is not the
ideal buy point every year, I believe it does illustrate the important consideration of looking for an
early buy point to be long stocks in this subset of years.
I am showing Robert J. Shiller’s data to reflect the market, using the S&P Composite Stock Price
Index starting in the 1870’s.
These monthly readings can be seen at http://aida.econ.yale.edu/~shiller/data.htm.
Year March Price December Price % Gain
1878 3.24 3.45 6

1888 5.08 5.24 16
1898 4.65 5.26 21
1908 6.87 9.03 21
1918 7.28 7.90 9

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1928 18.25 24.8 26
1938 10.31 12.69 23
1948 14.3 15.1 7
1958 42.11 53.49 27
1968 89.09 106.50 19
1978 88.82 96.11 8
1988 265.7 276.5 4
1998 1023.7 1190.0 16
2008 1316.94 877.56 -33
AVERAGE GAIN: 12%

Table 2: % Gain of Buy in March for the 8th Year from 1878 - 2008
This is certainly an impressive table of stock market performance, particularly when one considers
how far back in time we have gone. It illustrates that the decennial pattern has twists and turns to it
along the way, to which an investor should be able to take advantage of.
My Four Year Discovery

Future wealth is purchased with the scrutiny of the past.
Thanks to the writings of Gould, Smith, Gaubis, and Hirsch we have a good idea of when to expect
significant stock market highs and lows within the decennial pattern. It is a wonderful general road
map of what is most likely to happen in the future and alerts us to the fifth and seventh year buying
opportunities.
But it could be more specific... after all, we all want to know not only the precise week or the day but
also the exact time of day to buy or sell our stock. I think that’s a stretch... but we can get a whole
lot closer to determining the best time to buy with several different market tools.
The next bit of market knowledge I’d like to share with you is something I literally stumbled across
in 1970. It was the key ingredient in my ability to forecast the 1982 and 2002 stock market low
point… four years in advance, as well as the 2006 low! The bear market of 1970 had been good to
me. I’d made my first so called “killing” in the markets, about $300,000. That’s not much for now,
but back then as a 28 year old kid it counted and gave me a hefty dose of young man’s cockiness.
My “attitude” of being so smart as to find the bear market and sell it short also convinced me to stay
short after the low. I gave some of the money back, but was still nibbling on the short side in Oc-
tober of that year... when stocks rallied through the roof. Ouch! That hurt the pride as well as the
pocketbook.
I eventually wised up and went long. Late one night as I was licking my wounds, staring at old
charts, I saw something which changed my entire perspective of the longer-term timing.
What I noticed was the four-year space on my charts from the low of 1962 to 1966 to 1970. That
really got me to wondering, “was there some repetitive pattern at work here that no one had told me
about?” My father always told me that the little success I would have in life would be due more to
hard work and luck, than intelligence. With that thought in mind I began pouring over all the old
charts I had collected.
And there it was... going back in time... from 1962, there had been an important market low four
years earlier, in 1958! That got me excited. So, I next looked back four more years to 1954 and there
it was... the start of another bull market. By now my heart was pumping... had I found something
here? What happened in 1950? It was back to the charts and back to the start of another bull mar-
ket!
I was impressed! But, it just didn’t seem to make sense to me that we would have market lows
with such repetitive accuracy. What’s more, why didn’t they teach me this stuff in college or at least
someone talk about it in a market book? Why hadn’t anyone written about this? I had never seen this
in print; it was a sleepless night for me. I couldn’t stop thinking about the powerful effect of market
low, after market low, every four years. It was one of those things that just seemed too good to be
true. Was it possible my phenomenon would work in the future?
Market information of this nature plays tricks with one’s thinking. I had pretty well proven, to my
satisfaction, the power of the four-year phenomena --- but then reasoned that if I knew it, then it
would not work in the future. On top of that, my reactive mind added the idea that I needed more
examples out of the great unknown of the future to “prove” my discovery.
So, I waited with fear and trepidation, hoping no one knew my “dirty little secret” to see how this
four year “whatever it was” would pan out in the future. Along came 1974, again it worked. Then
1978 and a decent buy point surprisingly developed considering the stagnant market we had been in.
By this time I had “collected” three out of sample instances of the phenomena. They had all worked!
In some uncanny way stocks had continued bottoming in phase with this four-year cycle.
If that’s all you knew about the stock market back in 1978 you would have been waiting for the next
buy point to come four years later in 1982. Check your charts... that is exactly when the longest last-
ing bull market in the history of mankind began. Add four years to 1982 and you get 1986 as our
next projection. Even a cursory glance of the charts shows one yet another wonderful buy point in
the fall of that year!
Truly, my confidence in this phenomenon had increased to marked degree. To think an observation
made in 1970 was still having tremendous market success 20 years later. That was proof to me of
the validity of what I had seen late that night, when I was licking my wounds of being bearish too
long. Necessity, it certainly is the mother of invention!
The next charts break the market activity down so that you have a better view of what has taken
place from 1938 forward. I marked off the four-year phenomena and the low points. I ogle at these
charts like a 14 year old boy eyeballs at his first copy of Playboy magazine. They can greatly add to
your understanding of major cyclical moves and help you build confidence on your own.
It is not to say that a stock market low was found exactly every four years but that the next projected
market Timing | 27
best buying opportunity for market low will be approximately four years from the last one. In other
words the cycle can shift back and forth a little bit but it doesn’t matter all we need to do is go back
and find four years ago then come forward four years and there is a buy point.
Chart 27: 4 Year Phenomena Dow Jones Industrial Average 1926 - 1941
market Timing | 29
Chart 31: 4 Year Phenomena Dow Jones Industrial Average 1982- 1996
This simple little stock market forecasting technique suggests we should be looking for by points in
early 2017 and early 2021.
So Easy a Kid Can Do it
This four-year phenomenon is so simple, even a kid can do it! We simply add four years to the Octo-
ber buy point in 1986, and our imagery 14 year old kid could expect to call for a market low in the
fall of 1990. At the ripe old age of eighteen he watches a bull market begin. Well, that’s precisely
where a year and half-year bull market began. Imagine, we could have kids beating the pros with a
market timing system so easy to follow, all it needs is four fingers. Throw away the rocket science
math. Leave your lap top at home. You don’t even need a computer!
market Timing | 31
Our hypothetical kid investor now adds four years to the low in 1990 and makes this outrageous
forecast that stock should bottom in the fall of 1994. He’s not a kid any longer he’s now 22. Yet,
he beats the pants off the Wall Street experts, as the fall of that year began one of the most dramatic
price increases mankind has ever seen, an exponential rally similar to that leading to the high in
1929. Not only did the Dow Jones Industrial go up, virtually everything rallied; junk stocks, tech
stocks (is there a difference?), blue chips, red chips... everything rallied, everyone made money...
following the kid investor’s forecast to buy stocks in 1994.
As our kid investor approaches the ripe old age of 26, he’s looking for another market bottom, four
years after the one forecast in 1994. He’s made a killing in the ensuing market rally, so he’s got
plenty of cash to plunk into a market buying opportunity. Fortunately, he did not go to Harvard
School of Business, nor the Wharton School of Finance. He was smart enough not to listen to ana-
lysts, TV reporters, or read the Wall Street Journal. He just had this thing that about every four years
there should be a market bottom.
Our hypothetical investor is a little perplexed once 1998 rolls around. By now he is reading the sup-
posed wisdom of Wall Street. The vast majority of the analysts he discovers are calling for a major
stock market crash, as he kind of thought might happen (because most 4 years have early and mid
year weakness leading to a low). In the summer of that year prices take a terrible beating. Many
investors thought this was the slide that in reality came two years later. The air is thick with bearish-
ness; you could slice it with a knife in October of 1998. That is precisely when our rapidly maturing
kid investor decides to belly up to the bar and buy stocks one more time in the fall of that year. The
entry point is simple; it is four years after his 1994 wealth-making foray in the market place.
His ignorance or lack of market understanding, college degrees, and all of that paid off in spades, as
stocks began another 18 months of an almost vertical market rally. His timing could not have been
more impeccable! Once more our inexperienced, uneducated, but by now fabulously wealthy, kid
investor had hit it right on the button.
He did what the pros were not able to do... he did what the fund managers were not able to do... what
the brokers and investment advisers were not able to do... he outsmarted them all with his annual
four-year forecast.
The Meaning of 2002 - “142 Years of Market Success”

Read now what I wrote in 2001…
I have stock market prices as far back as 1854. It appears this four-year phenomena began operating
in 1858. The market was close to an important low which actually came in 1859. The next indica-
tion would’ve been four years later in 1862, with one of the strongest bull markets of the entire 1800
time. Fast forward in to 1866 where we can find a low point established in the fall of that year, con-
summating into the beginning of the 2 1/2 year bull market.
You know the drill; we add four years to 1866 and come up with 1870 as a buy point in the stock
market, which was exactly on target. Michael Jordan, was never more accurate. Four more years
produces 1874. That did start a nice up move into 1875, leading into one of those long-lasting bull
moves investors dream of. Our next buy zone would of course be 1878, which was a spectacular one
in that the equity market danced to the bull’s tunes in perfect syncopation with our four-year phe-
nomenon.
This of course meant we would next be looking for a buying opportunity in 1882. Shucks, this one
was not so good. It flat-out did not work; prices continued going down until 1884. However, any
money lost at that buy point was recouped four years later as 1886 heralded in another bull market
than did not culminate until 1893.
Our next four-year phenomenon buy point was scheduled for 1890. Interestingly enough, the fall
of that year did present a wonderful buy point for a bull market that lasted into the winter of 1893.
Again, the four-year phenomenon scored a major victory... the averages rallied.
The next call was for a low in 1894. This one was a bit premature. Yes, prices did rally off the low
of the year of 1894, but the real market low came in 1896. Our patient investor awaited the next
buying opportunity to occur in 1898. That patience was rewarded with substantial investment gains
as the market took, off once more in line with our four-year phenomenon.
Oh my gosh... the turn of the century had taken place, a millennium had come! Could, and would,
this handy dandy little pattern work in both centuries? It would suggest to our investor back then to
purchase stocks in 1902, four years after the 1898 buy point. Unfortunately this market forecasted
turning point was not so spectacular... prices did rally late in that year but came down rather sharply
in 1903. Four years later we would’ve looked to step in again on the long side as a buyer in 1906.
Our reward? Failure.
1910 would’ve presented us the next opportunity to see if stock prices were moving in phase with
the four-year phenomena. Given the prior two misses, I’m sure we would have been shaking in our
boots, wondering if this phenomenon had started to falter. Because while prices did rally at this
time, it took a while and there certainly was no spectacular up move.
Then, in gang buster like fashion, the four-year phenomena started to click in like digital clockwork.
A market low came in 1914, 1918, 1922, 1926, none appeared in 1930, but reappeared in 1934,
market Timing | 33
1938, 1942, 1946, 1950, 1954, 1958, 1962 and onto the present. Four years after four years, in an
almost robot like fashion, the phenomena kicked in working as well in the second 100 years as it had
in the first.
Clearly one can learn from the past, and the lesson that I see here is to expect stock market lows in
harmony with these four-year phenomena. That means we should expect a low in 2002 (1998 + 4)
which just so happens to coincide with the decennial road map forecast for an important market low
in the 2002 - 2003 time period.
Double Confirmation
In other words, we kind of have a double confirmation here --- both major long-term cyclical refer-
ence frames are telling us to expect an up-move in stock prices at this time. While the decennial pat-
tern is something general we can most definitely focus or narrow down our window of opportunity
by a substantial degree in synch with the four-year phenomena pattern, thus isolating the best of the
best.
As an aside, we can also see, in that sense, a market bottom is called for by the four-year phenomena
in 2006, four years after the 2002 low, which dovetails with our fifth year scenario. This suggests to
me not only will the stock market rally in 2005 but a buy point to be found in 2006 as well, indicat-
ing some type of substantial rally in stock prices is out there for us to take advantage.
Even better yet may be the 2014 market forecast low, thanks to the four-year phenomenon, which
then leads into the fifth-year expected rally in 2015. Should you and I both be so lucky as to still be
trading at that time, you know which side of the market I’ll be on, and you know I will have covered
my short sales.
Just so you know, the use of the decennial pattern as well as my four your phenomena is not some
conjecture on my part, some bit of numerology applied to stock prices. Let me tell you a little bit
more about my last book touching on this subject. In 1981, while standing at a supermarket check-
out counter, I noticed the then best selling book, “How to Prosper in the Coming Bad Years” by
Howard Ruff. Standing there it struck me that what investors needed was a dose of good old-fash-
ioned optimism. It was time for a new book, a new view of the economy. That began my writing
“How to Prosper in the Coming Good Years”, my refutation to the purvey yours of pessimism.
To a large degree that book, and bullish view, was based on what you just read about. I knew the
decennial pattern should pick in for a low in the 1982 or 1983 time. I also knew that my four-year
phenomenon was calling for low at the same time as the larger pattern.
As the book promotion began in the winner of 1982 things look very bleak. Most of the folks who
interviewed me were shocked by my optimism, by my predictions of good times to come and by my
panning of the pessimists.
The most notable experiences were on the Merv Griffin show, an interview by Dan Dorfman, and a
never to be forgotten radio talk show in Detroit.
The talk show was supposed to last for 30 minutes, it began with a brief introduction, my expression
of extreme optimism, the good times would come and rather quickly. Then we went to the phone
lines; they lit up like a Fourth of July night. The callers to this station where upset, angry with me
for being so optimistic. They did not want to argue or discuss the political or economic situation,
reasons why things might get better; they simply wanted to shout and scream, taking out their frus-
trations on my optimism.
It was no wonder, stocks have been down to sideways for a year. Inflation had been rampant during
Jimmy Carter’s tour of duty and investors. Even those of you who bought and held gold had little to
show in the way of profits.
For a long time, long term investors had only losses to show for their efforts and risk. This condition
breeds contempt and disbelief for bull markets. Such conditions are exactly what sets up the oppor-
tunity for major buy points. Why? You see, most investors think the future 6 months to a year will
be pretty much like the last six months to a year. They are overly influenced by the current trend…
they are looking back, not forward.
The thirty-minute interview opened up to a three-hour telethon that Jerry Lewis would have been
proud of. The mere fact people just could not accept that things might get better, perhaps the future
of America was bright and not dim, assured me of my correctness.
In retrospect this is one of the all-time market calls. Wherever I went throughout America, some
thirty-two cities in 28 days, my message was clear, “mortgage your house, buy stocks, then get a
second mortgage and buy more.”
Here we are 20 years later... entering a two and three year time frame with a four-year phenomenon
kicking in at the same market juncture.
Let’s see, if we can get this straight now; every four years we expect a market bottom. The last one
was in 1998. So if we simply add four years to 1998 we should expect the next buying opportunity,
if my math is correct, 1998 plus four more years, in 2002. Since the 1998 low came in October of
1998, I would expect a market low to occur about the same time; the fall of 2002.”
That’s word for word out of this original manuscript in the fall of 2001. Sure enough, the 2002 buy
point came. Was this just a rally in a bear market? The history of these four year buys suggests to
me that 2002 was a major buy area, not just a bleep before a crash to lower price levels.
My Forecast of the Future
Incidentally one should also be looking for significant market bottoms in 2010, 2014, 2018, 2022,
2026, 2030, 2034, 2038, 2042, 2046 and 2050. Of course we will always want to go back to the last
low or blast off point, expecting a buy about 4 yeas later.
There it is; my forecast for the next fifty years of market activity. Many things will happen in the
next fifty years. There will be huge changes in society, in business, in communications, even reli-
gions and politics. Yet, I suspect the four-year phenomena will continue to be the clockwork of the
marketplace. I say that, not because this four-year phenomena has done such an exceptionally good
job of forecasting prices from 1962 forward, but because it also did such a good job of forecasting
prices prior to 1962.
One of my studies was to do a count of this cycle of all years of market activity from 1858 forward.
I found that 86 percent of the time stocks bottomed in perfect harmony with this four-year repetitive
pattern. Accuracy like this is extremely difficult to find in the stock market. This certainly suggests
market Timing | 35
something beyond random activity is involved here. The mere fact that the four phenomenon has
been so influential for so many years suggest rather strongly to me it will continue performing for
many years yet to come. It is ironic to think that something as simplistic as this four-year pattern has
had a better job of calling major market lows than virtually any of the fancy indicators and invest-
ment strategies we have cooked up with fancy math and econometric models!
Some people suspect this has to do with the presidential election cycle, which does neatly dovetail
at times with this four-year phenomenon. Others I have shared it with think it has something to do
with the planet Mars (Yes, I have eclectic friends). Some say its part of the decennial pattern. On the
other hand, the very few people that know of this pattern seem to think it may be a natural cyclical
response to human activity or is perhaps due to the influence of Federal Reserve Activity.
I really don’t know. I can come up with some conclusions and reasons to explain why the phenom-
ena occurs. But again, I wonder... does it make a difference? The facts speak rather well for them-
selves. The market has had way too many bottoms coming in way too many times (at the right time)
for me to monkey around much with the data. I would rather just accept it. What is, is. To me it’s
as simple as that.
Well there you have it. My research of the past to help us understand the long term moves of the
future. The following table summarizes the yearly influences of the decennial pattern.
Long Term Cycles In A Nutshell

Years Ending In 2 Buy Points
Years Ending In 5 Rallies All Year Long
Years Ending In 6 Buy Late In Year
Years Ending In 7 Late July Sell Off To A Buy
Years Ending In 8 Almost As Good As 5 Years
Years Ending In 9 A Top Is At Hand

Table 3: Yearly Influences
I have found no biases for the years not mentioned above. Treat these simple little rules well. They
have certainly been kind to me and have explained the future better than any other cyclic or econo-
metric model I have seen.
From the very long term, let’s now turn our attention to the yearly cycle or pattern of stock prices.
Dispelling Some Notions
When Conventional Wisdom is Not Good Enough

Most market addicts will tell you one of the “sure thing trades” in the stock market is to sell in May
and walk away. True or false? In a moment you will know…
Ah, the market mavens and wizards are not too far removed from simple wives tales. One of the
most oft repeated is that it’s best to exit the market in May. Chart 35 succinctly says it all… or does
it? The gold line represents what would have happened to an investor who bought in May and held
through October. Pretty lackluster compared to a buy and hold in light blue, or buy in November and
sell in April, the dark blue line.
As the bottom line in the chart shows, buying in May and holding through October has seriously
under performed a buy and hold strategy (or the one I favor; to buy in the Sept/Oct time frame). In
fact there is a huge difference... but there is a catch here.
Chart 35: Comparison of Sell in May
These are gains since 1950. Well that’s just fine and dandy but what if, as 1950 dawned upon hu-
manity, you ran a seasonal data on the Dow 30 from the first part of the century through 01/01/1950?
What would that chart have looked like?
I’m not the type of guy to raise a question he can’t answer… here it is in Chart 36… the known sea-
sonal as of 1950.
market Timing | 37
Chart 36: Dow Seasonal Pattern 1925 -1950
The future did not quite unfold that way though.

In fact the very first year you could have relied on the data, 1950, would have found you buying at
the end of May, just as a major slide began. The next buy date, the end of December did much better,
but it missed the low in the start of the 4th quarter of 1950.
If we wait until the start of 1950 and build a seasonal model on the data from 1900 thru 1959 we get
a “road map” for the Dow 30. The highs and lows of the seasonal tell us to buy at the end of May
and sell the first of September… exactly opposite of what the current spate of seasonal experts sug-
gest. There is also a nice trough in the seasonal pattern at the end of the year, suggesting another
excellent buy point.
Chart 37: Dow Seasonal Pattern 1950 -2015
End of May Still a Great Buy Point!
What a shocker... the data through 1959 tells us to look for a buy point at the end of May, ride the
rally to mid August, exit and get back in toward the middle of November. Two things stayed in the
data; the year end rally and the late May, early June buy point.
That supposed seasonal soon fell apart as numerous years in the ensuing time set up sells in late
May, not buy points.
Can we trust these shifty seasonal patterns? We simply must do it… we must face up to the facts
and ask if the supposed seasonal influence in stock prices is random or factual, shifty or sure
thing.
In getting to the truth of this matter I tested various time periods to see what data sample held up the
best. The next chart shows the seasonal from 1950 to date. It presents a nice clean picture of sea-
sonal opportunity… but it works best in the current years, not the past.
While the seasonal from 1950 to date appears to work well now, I’d like something that works well
on all data. To uncover a “sure thing” stock market seasonal I dropped off the crash of 1929 as it
biases the data way too much. Ditto the crash of 2000-2002. I did this by looking at the seasonals
from 1900 thru 1928, from 1932 through 1949, 1949 through 1980 and finally 1980 through 2000.
Here are those seasonal charts. They present us with some very valuable information.
market Timing | 39
The Best of the Best, 1900 to Date

By adding all years and not focusing on just the last 20 or last 50 years, we get a pattern that is very
different. In this case the assimilation of all the years gives us a better pattern, road map, or plan of
action than that from a more limited view. Here it is:
Chart 38: Dow Seasonal Pattern All Years
The pattern is: up from the end of the year into mid April (tax time, makes sense), then down into a
low or trough or resting action close to the end of June. That ensuing rally should lift prices into the
first week of September when it’s get out time. Then, a look-see for an entry at the end of October or
the middle of December.
Here you have the most important seasonal points. Even these will vary. They will never be fixed
and should be thought of as a suggestion, not a call to action. The “sell in May and walk away” pat-
tern is there, but not as strong in the data from 1900 into the 1950’s. It is a more recent unfolding of
price action than many suspect.
Politics… a Special Consideration
The Trend is Your Friend and So is the President

It doesn’t matter if there is an R or D after his or her name. They all goose the economy to get re-
elected. Here’s how we take advantage of that.
It is truly all about the economy (and wars) when it come to the politics of getting elected and re-
elected. I see no reason why the future will be different than the past years. For that reason I’d like to
visit a chart of the seasonal pattern in stocks and back that up with interest rates.
Let’s begin with a look at the Bond market to see what the typical seasonal pattern is in the all im-
portant --- critical to stocks --- interest rate game. I’m showing in Chart 39, see the blue line below
Bond prices, the seasonal pattern of Bonds for all years from 1976 (the years bonds started trading)
forward. What we see is a typical decline in Bond prices --- higher rates --- as a year begins, then
lower rates in the May time zone.
Chart 39: Bonds Seasonal 1976 Forward
As with all seasonals, this is not perfect. It’s a general road map of what rates/prices should do. It’s
an aid, a road map of the most likely time to see market reversals. This pattern is known by those of
us that look at seasonals.
Yet, there is another chart I’d like to share with you. Chart 40 is the seasonal pattern on the Bond
market --- but only in years of Presidential re-elections.
It shows a distinctly different pattern than that of all years combined. This chart is of the yield, so an
up trend means lower bonds prices, a down trend means higher bond prices… it’s just upside down
from the first chart above.
It seems only logical to think that Presidents and Parties influence the Fed, either with direct arm
twisting or passing legislation. The evidence is quite strong on this point, and to my best knowledge
this view has not been presented outside of my work.
As you can see the years in this study skip every 4 years to pick up the re-election year, which means
we should look for this the general pattern in 1988, 1992, 1996, 2000, 2004, 2008, 2012 and 2016
coming up.
market Timing | 41
Do not get all lathered up with the size or magnitude of the swings… focus instead on the dates (time
zones) when Bonds have begun their moves in these years.
Chart 40: Bonds Seasonal Presidential Re-elections
These charts are thanks to my long time buddy Steve Moore at Moore Research (mrci.com)
The lesson to learn from the past is that rates should start to drop at the end of May into the first of
August, then from September into mid November rates again decline.
What we see here is that rates go higher in re-election years, on balance, until May, then drop rather
rapidly all the way into the election. Hey, if you were running, you’d do it too. It’s not just the Prez;
the Senators and Congressmen have to go home to brag about what goodies they brought for their
districts.
As they say, not all years are the same… especially when it comes to being the President. The next
clip is of the year after the election. This is a bird of a different feather than the chart we just saw in
terms of the timing and duration of the fluctuations in interest rates.
Chart 41: Bonds Seasonal Presidential Post Election
Stocks and Bonds… Hand in Glove
Interest rates are the most reliable indicator of future stock prices. When rates go up, soon stocks
will go down. When rates decline, shortly thereafter stocks rally. It is just that simple.
With the perspective of what the Bond market and interest rates do in the election year we now have
a better understanding of the “whats” and “whys” of stock prices. The next chart of the seasonal pat-
tern of stocks in just the election years.
Chart 42 of the Dow from 1924 forward shows the same 4 year skip, just looking at data from elec-
tion years. Again, don’t get too carried away and think the market in 2008 will move exactly like
this pattern. It won’t. But, it should be similar; note the pattern does not use any data from 2004, yet
gave a suggestion of a January peak, a February buy point leading to a late March early April decline
that gives way to a buy at the end of May.
market Timing | 43
Chart 42: Stocks Seasonal Presidential Election Years 1924 Forward
Stock Prices in Election Years: “Buy in May, Make Political Hay”
That’s what the record of the last 20 presidential elections suggests to us. Almost on cue, stock
prices have dipped, giving way to a May mud slide and setting up a buy point. This has been a very
strong seasonal pattern, well worth playing for this next year. But even at that, it’s not one to do
blindly… seasonals are pretty shifty, as you have seen.
As an aside this data was presented first to subscribers of my stock newsletter on May 1, 2004.
Here’s what followed in terms of market performance 8 years later in 2012.
Chart 43: 2012 Stock Market Price Action
Rules for the Right Time to Buy and Sell

1. I want to be a buyer of stocks the last week in October every year, or perhaps buy a little sooner
if stocks are getting clobbered or indicators you employ encourage you.
2. I will hold for 6 to 9 months, unless those same indicators of yours are excessively bearish.
3. Years ending in 5 are treated differently. Buy early in the year and hold until May of the next, a
“6” year.
4. Presidential Years are also traded based on the strong pattern presented here.
5. BE ON GUARD OF YEARS ENDING IN ‘0’ AND ‘1’.
Speaking of politics, there is a very little known fact of market performance in Jeff Hirsch’s 2015
Stock Traders Almanac. Jeff broke down market performance with a Republican President up about
7% on average vs 10.5% when a Democrat has been in charge.
That has been widely known, but Jeff went way beyond that. He found the best performing years are
when R’s control Congress, up almost 17% vs. D’s in control of Congress with a 14% average gain.
Here’s the most interesting fact from his research; when we have had a Democrat President and a
Republican controlled Congress, like 2015, stocks have done the very best, up almost 20% on aver-
age!!
market Timing | 45
Presidential Cycle Data 1900 - 2006

Year in Cycle Annual Average Gain Years Up Years Down
Post Election Year +5.0% 13 14
Mid Term Election Year +3.2% 14 12
Pre Election Year +12.6% 21 5
Election Year +9.0% 18 8
Table 4: Presidential Cycle
To give you a better understanding of the power of presidential politics for the stock market, I’m also
showing you each individual year within that presidential cycle. This pattern has been operative for
many years in the stock market, and given the nature of politics, I see no reason why this will stop.
Chart 44: Dow Jones Election Years

Chart 45: Dow Jones Post Election Years
Chart 46: Dow Jones Midterm Election Years

market Timing | 47
Chart 47: Dow Jones Pre Election Years
The pattern of these years is almost unchanged from when I first showed this concept in my 1970
book on stock investing and trading. That is a very long record I would not want to bet against.
Fundamentals Matter
As you are seeing, there are obviously cyclical and presidential patterns to stock prices. They are fasci-
nating. They are indicative of what will happen in the future, but let’s not get too far carried away with
them. Here’s why.
These cycles and patterns have more to do with time than they do magnitude. Clearly they help us
in understanding when to expect significant market rallies and declines, but as we get to these time
zones we need to look at the fundamental conditions to see if the cyclical aspects are supported by
good or bad fundamentals.
Markets don’t move just based on cyclical activity. Fundamentals really do matter and here are some
of the fundamental indicators I have found to matter the most.
Fundamentals Can Predict the Future
Chart 48: The Yield Curve vs S&P 500 Performance
Always an admirer of Nick Wallenda, we went out on our own tight wire in December of 2013
calling for a major stock market low in November 2014. The above chart is a direct lift out of that
report. Our 2014 mid year report in July was more focused saying this suggests, “…stocks to bottom
and or rally in October…2014”. This forecast was based on the Yield Curve.
You can gaze into crystal balls or the skies at night but never forget it is fundamentals that drive
prices (magnitude); the dances along the way are to the tune of some other piper.
At the current time this is written in 2015, the Yield Curve is telling us to expect higher prices at
least until April 2016 when it turns down. Time will tell. Charts courtesy of www.macrotrends.net.
market Timing | 49
Chart 49: The Yield Curve vs S&P 500 Performance
You will also want to follow this spread to help you identify when we’ve reached significant market
highs and lows. First of all, if you don’t understand what the yield spread is here’s a definition
We will be looking at a yield curve which is simply a graphical relationship the yields available
between short and long term debt securities. Typically the comparisons between the 30 year and 10
year notes or bonds.
What is significant is that an inverted yield curve (I’ll explain that in a moment) has proceeded seven
of the last seven US recessions.
A steep rising yield curve indicates investors expect strong future economic growth. That’s bullish
for stock prices. When the yield curve is inverted, sloping down to the right, that means investors
expect sluggish economic growth in the future and lower stock prices. At times the yield curve can
be flat which generally indicates investors are unsure about future economic growth.
If you would like to do some more reading on this important indicator I would suggest you read a re-
port by the Federal Reserve Bank of New York, “The Yield Curve As a Predictor of US Recessions”,
authored by Frederick Mishkin.
His work is fascinating. It tells us that when the yield curve is positive from 0.22 and higher, there’s
only a 20% probability of entering a recession. However when the yield curve is negative there is a
30% probability of entering a recession. As that yield curve goes more negative, say to -0.82 there is
a 50% probability of a recession, and when it hits -1.40 there is a 70% probability of a recession!
Here is a chart that shows the treasury spread from 1960 forward (as well as a recessions) to give
you an idea of how powerful this data is.
Chart 50: Treasury Spread
There is a wonderful web site, www.stockcharts.com, that allows you to follow the yield curve as
well as see how it performed in the past.
The next chart shows the yield curve, that’s the red line on the left side of the chart, versus stock
prices in April 2000. As you can see the yield curve was the climbing. That’s negative and in fact
stock prices shortly thereafter plummeted.
As we approached the market low in 2002, look at the yield curve. It was rising and had been for
some time which is indicative of long-term money turning bullish, thinking the future will be better.
It was. Stock prices rallied from 2002 into the late 2007.
market Timing | 51
Chart 51: Yield Curve 2000
At the peak in 2007 we are presented with quite a different picture. A flat yield curve indicating there
would probably be difficulty ahead and of course there was. Near the low point of 2009, there was a
far different picture. The yield curve was positive and sloping upward a very bullish indication.

The Cassandras were crying of another bear market to begin somewhere after 2009, offering many
reasons why stock prices should decline. But the yield curve has remained in a positive curve through
June 2015. The suggestion, obviously, is the economy is strong and that expectations of the future are
positive.
The large selloff in 2011 caused many people to think we’d entered another bear market. They were
wrong. Had they only looked at the yield curve, they would see how it was an eight sharp rising, posi-
tive formation. That’s simply very bullish.

market Timing | 53
TED Spread and Stock Prices
Many traders are well aware of what is known as the “TED spread”. It is the difference between the
futures contract for US Treasury bills and the futures contract for Eurodollars (Treasury to Euro Dol-
lars).
A few years back this was a well promoted spread trade that basically called for selling when very
high and buying when very low. The problem was, what was very high then became very much
higher. Thus, a lot of short-sellers were burned. However, buying when low has always been profit-
able. But, you may have to hold for several years before the trade is successful.
A quick study of Chart 55 of the last four decades gives us a better idea of what are now the high
and low zones for potential buying and selling, and also the amount of time you may have to endure
before success is achieved.
This spread is an indication of credit risk in the marketplace because treasury bills are considered to
have less risk than the Eurodollar futures contract. This means that as the spread increases, the risk
of default is increasing… credit markets are shaky and investors will be looking for a safe haven. As
a spread declines there is less risk. Thus, the financial community is stable and stock prices more apt
to rally.
Chart 55: TED Spread
My observation is the spread can be used to give us a fundamental idea of risk exposure to stock
prices. I have drawn off a line (red line in TED Spread chart) for the last 30 years showing high lev-
els of credit risk as evidenced by this spread. When it is high we have been in bear markets or stag-
nation in stock prices. When it is low… like now, the bulls rule Wall Street.
I believe fundamentals set the stage for bull and bear markets. This stage setting, as measured by the
TED spread, remains bullish. A warning for the stock market comes when it reaches the 140 area.
Chart courtesy www.macrotrends.net.
Inflation and Stock Prices
You will hear many arguments about inflation and its effect on stock prices. Some will say it is good.
Some will say it’s bad. Some say it doesn’t matter. I think it does matter, but only at certain time pe-
riods. Chart 56 shows when inflation is greater than 5%, stock prices selloff and often substantially. I
would not be too concerned about inflation until we enter what would be for America, hyperinflation
(above 5%). At that point it’s time to take a walk away from Wall Street.
Chart 56: 5% Inflation
Chart 57 shows what happens when an investor is long stocks when inflation is below 5.3%. That’s
the blue line. The black declining line is when an investor is long stocks when inflation is above
5.3%. Clearly excessive inflation is something to put investors on the sidelines.
market Timing | 55
Chart 57: 5.3% Inflation
Fed Funds Drive Earnings?
Is there a driving force to earnings in the United States? It looks to me like the following chart shows
that when Fed Funds are increased, in other words interest rates rise, we see an increase in hourly
earnings. By the same token when there’s a decline in interest rates, look what has happened to aver-
age hourly earnings.
During the massive decline in Fed Funds and interest rates from 2008 forward, hourly earnings stabi-
lized, going neither higher or lower. My guess is once Fed Funds or rates increase we will then see an
increase in hourly earnings. This gets very interesting because an increase in hourly earnings means
there will be more consumer spending. It is consumer spending that largely drives stock prices. After
all, someone has to buy stuff corporations make so the corporations are profitable.
Chart 58: Fed Funds and Hourly Earnings
Another unique set of data regarding interest rates is that since 1971 there been seven periods when
the Fed has raised rates. In each of those periods the market actually gained an average of almost
20%. On balance, interest rate hikes are positive…at the beginning of the cycle… and negative at
the end of the cycle. In other words, it is not the first few small increases in interest rates that hurt. It’s
the ones late in the cycle, when the Fed realizes the economy is too strong, approaching a speculative
bubble, that they put on the brakes. Interest rate increases at that time are the ones that hurt.
market Timing | 57
Unemployment and High Wages
Another significant relationship to pay attention to is what causes unemployment. It looks to me like
the cause is average hourly earnings. Our next chart shows what seems to be the largest driving force
of unemployment… higher wages. Just look at the chart; when average hourly earnings have been
increasing, getting above 4% per annum, then the unemployment rate rises.
Chart 59: Unemployement Rate vs Avg Hourly Earnings
Once the annual increase in average hourly earnings drops below 2%, then unemployment goes
down. This should be interesting fodder for those seeking a minimum wage law. Certainly nothing
seems to stop job creation more than a high average increase in annual employment pay.
P/E Formula for Predicted Future Returns

Professors Ruben Trevino and Fiona Robertson looked at price-earnings ratios for the Standard &
Poor’s 500 stock index from 1949 to 2000. What they were looking for was a ratio of P/E to future
performance. What they discovered was not new; high P/Es led to lower returns during the following
five to 10 years. Their formula for measuring the P/E ratios, however is new and so, so simple.
Studies done by these two show you can predict the five-year average annual stock return simply by
multiplying the current P/E by 0.57, then subtracting the result from 20.67. Expected five-year aver-
age stock return = 20.67 – 0.57 (current P/E).
You can get the P/E for the Dow at:
http://online.wsj.com/mdc/public/page/2_3021-peyield.html
That’s all there is to it. No fancier math is needed. Let’s see what this formula is telling us now. (I
originally presented this information above to my Right Stock Newsletter subscribers in November
2004. You can see what took place—after the formula was used).
The current (as of September 20150 all important 12 month forward P/E ratio on the Dow Jones av-
erage is 15.9. So when we multiply that by 0.57, we get a result of 9.085. The last step is to subtract
this from 20.67. The result tells us that the current P/E suggests an annual return of 11.58% over the
next few years.
To put this into perspective, we need to keep in mind the average return has been 10.46%. So the
current projected return is greater than the average. There is only one conclusion I can draw from
this… stocks are undervalued.
In January, 2008 the S&P 500 P/E ratio was 21.76 giving us a 8.23% value. A sharp indication that
value was fluffy because the average return has been 10.46%
When to Buy
It’s time for you to learn my favorite long-term stock market by indicator. All of my long-term stu-
dents know about the indicator. It has done a bang up job of calling ALL stock market lows since and
before the 1929 depression. Yet it has problems. It is not perfect. Sometimes it buys a little early, but
by and large this is the best stock market indicator I have ever seen to tell us to buy stocks..
Let me show you an example of just how good the 13 week rate of change has been. I developed the
trading rule for it in the late 1970’s. The rule is: subtract this week’s closing price from 13 weeks ago.
When it is < -15, buy stocks. That is the entire entry rule which works for our requirements 3, 4 and 5
above.
I’ll let the record speak for itself. I suggest you take a look.
market Timing | 59
Chart 60: 13 Week Rate of Change 1936 to 1943


market Timing | 61


market Timing | 63
Many of these entries could not have been any better; they triggered a long entry the week of the low.
Seldom is one’s long term timing this impeccable. Yet, as the 1966-1971 time period shows, buying
the absolute low week is not out of character for this index. It is not perfect though as you can see in
some of the examples.
There’s a big difference between how markets pop and how they bottom. It’s my belief that markets
top because eventually the economy starts to soften and then stocks tumble. Bottoms however are far
different. They are created almost the instant price get so oversold. There’s so much value, the big-
money rushes in buys and drive stock prices sharply and strictly higher. That’s the problem with any
trend-following technique that gets you into the market on the long side… It’s late. Often far too late.
You’ve missed the ideal buying point.
Market Buy and Sell Rule
My 13 week rate of change sidesteps that problem. It gets you buying shortly before or right at the
market low. What could be better?
Market tops, on the other hand, are very deceptive. They are long drawn out affairs. I’ve yet to find
an indicator that says, “this is the day of the high.” Our business is just not that simple. But clearly if
the yield curve is inverted or sloping, unemployment has turned up, inflation might be high and our
P/E evaluation model shows a little future for stock prices... it is time to leave the party to others.
You now know the right or best times to buy stocks, as well as have an understanding of the longer
term cycles and patterns. So it’s time to find out how to find the right stocks.
Disclaimer
IMPORTANT: The risk of loss in trading futures, options, cash currencies and other leveraged
transaction products can be substantial. Therefore only “risk capital” should be used. Futures,
options, cash currencies and other leveraged transaction products are not suitable investments for
everyone. The valuation of futures, options, cash currencies and other leveraged transaction products
may fluctuate and as a result clients may lose more than the amount originally invested and may also
have to pay more later. Consider your financial condition before deciding to invest or trade.
NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL, OR IS LIKELY

TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE DISCUSSED WITHIN THIS
SITE, SUPPORT AND TEXTS. OUR COURSE(S), PRODUCTS AND SERVICES SHOULD
BE USED AS LEARNING AIDS. IF YOU DECIDE TO INVEST REAL MONEY, ALL
TRADING DECISIONS ARE YOUR OWN. OUR TRACK RECORD IS FROM TRADES
GIVEN TO SUBSCRIBERS IN ADVANCE AND ARE NOT HINDSIGHT. THE RESULTS
MAY HAVE UNDER-OR-OVER COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN
MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. HYPOTHETICAL OR SIMULATED
PERFORMANCE RESULTS HAVE CERTAIN LIMITATIONS. UNLIKE AN ACTUAL
PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL
TRADING. SIMULATED TRADING PROGRAMS ARE SUBJECT TO THE FACT THAT THEY
ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. THE RISK OF LOSS IN TRADING
COMMODITIES CAN BE SUBSTANTIAL. YOU SHOULD THEREFORE CAREFULLY
CONSIDER WHETHER SUCH TRADING IS SUITABLE FOR YOU IN LIGHT OF YOUR
FINANCIAL CONDITION.
CFTC RULE 4.41 - HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE

CERTAIN LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED
RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE
NOT BEEN EXECUTED, THE RESULTS MAY HAVE UNDER-OR-OVER COMPENSATED
FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF
LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT
TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO
REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO
ACHIEVE PROFIT OR LOSSES SIMILAR TO THOSE SHOWN.
Larry Williams
Stock Trading and
Investing Course
Part 2
A comprensive guide
the right stocks at
the right time.
Part 2
Stock Selection
Contents
You Can Beat the Market 3
Mutual Fund Myth 4
The Concept of Stock Selection 6
Introducing the Darlings of the Dow Concept 16
Stock Selection Techniques 19
The Primary Measurements of Value 31
Debt 32
EBIT 35
Price to Book - One of Ben Graham’s Favorites 39
Cashing in on Cash Flow 40
Yield; the Right Way? 41
A Look at Net Working Capital 43
Return on Equity 44
Momentum Players Are Destined to Fail 53
You’ve Seen the Rest, Now it’s Time for the Best 58
Putting it All Together... the Rubber Meets the Road 61
Larry Williams Simple Little Stock Investment System 64
Disclaimer 76


You Can Beat
The Market
Now that you’ve learned the best time to buy stocks, it’s time to teach you the
best stocks to buy. That’s the way you can beat the market.
- Larry Williams
No part of this publication may be reproduced, stored in or introduced into a retrieval system,
or transmitted, in any form or by any means (electronic, mechanical, photocopying, recording,
or otherwise), without the prior written permission of Larry Williams CTI Publishing and Larry
Williams.
The distribution of this manual via the Internet or via any other means without Larry Williams
CTI Publishing’s and Larry Williams’ permission is illegal and punishable by law.
Imagine you and I are at a gun range. OK, bow and arrow range for those opposed to the right to
bear arms. I propose a bet to you. “I’ll let you stand three feet from the target and then you can fire
away. If you hit the bull’s-eye once out of three shots, I pay you $1,000. If you miss you pay me.
Fair deal?”
Sounds pretty easy, but once we get three feet from the target, I blind fold you and move the target.
It’s still 3 feet from you, but just not where it was. Thanks for the grand.
So it is with the market; people do not know what “Beating the Market” means. So let’s define that
before we begin.
Some might say it means making a million dollars. That’s good but if you start with $5,000. That’s
a lark. While if you start with $10,000,000, it’s very doable. It’s all about a reasonable percent gain
on your investment, with as little risk exposure as possible.
In the beginning of the course manual I pointed out that from 1926 to 2005, the S&P 500 returned an
average annual gain of 10.46 percent. While that may not seem like much, if you originally invest
$100,000 and wait 20 years, you end up with $ 731,308.76. If, in addition to the original investment,
you put up another $10,000 each year, when you are ready to cash out you have $1,397,985.30.
Generally speaking, the returns from what I teach have been around 18% per year. The difference
between that and 10.46% is huge. With the higher rate of return, the fellow who put up $100,000 and
waited 20 years ends up with $2,739,303.46 (370% more). While the investor who added $10,000 a
year, cashes out with $4,469,513.51. Playing for a higher rate of return has great rewards.
As an aside here, suppose you bought a house 20 years ago --- with cash --- for $100,000. Your
holding cost would have been about 8% per year, for a total outlay of at least $160,000 and prob-
ably more. What would that home sell for today? $730,000? That seems high, and of course you
had $160,000 of carrying costs. When you go to sell it, you get whacked with a 6% commission,
for a loss of about $44,000. (I bought a house 20 years ago for $1,000,000. It did not sell for
$7,310,000).
Stocks, if played properly, are very lucrative.
If you beat 10.46% per year, you have beaten the market... well, kind of. Some years the Dow 30
may soar and tack on a 20% gain. So, if you rack up 10.4% that year the market beat you! Ulti-
mately you want to out perform the market every year, making more than the averages do in a down
year or at least losing less.
There you have it, the bull’s-eye of investing. The sad irony is that not many people --- and not most
mutual or hedge funds --- do appreciably better than the averages!
Mutual Fund Myth
Why not just put all your money in a mutual fund and let the pro’s do it? The February 1999 issue of
Smart Money Magazine saw fit to phrase the question on the minds of 1998’s mutual fund investors
in these words:
Stock Selection | 5
“How could the market be up 22% in 1998 and my returns be only half that?”
“Why, you ask, do all my mutual funds suck?”
For many years now the record for equity mutual funds has not been good, though millions of dollars
of shareholders’ money is spent annually by mutual funds promoting themselves with the notion that
they have “expert” stock pickers. The sad truth (or the funny truth, if you’re in a laughing mood) is
that the vast majority of mutual funds under perform the returns of the stock market (as represented
by the S&P 500 index).
Because of their excessive annual fees and poor execution, approximately 80% of the mutual funds
under perform the stock market’s returns in a typical year. Over the past couple of years, that num-
ber has been going up, as mutual funds have been raising their fees to even higher levels.
The average actively managed stock mutual fund returns approximately 2% less per year to its share-
holders than the stock market returns in general.
Why is that? It’s simple math… if they can just keep even, do the same as the averages, they still
have to ding the fund for management fees… hey, someone has to pay their salaries, pop for their ce-
lebrity golf tournaments and such. Guess who that is? It’s you. They take your money so they can
sponsor Tiger Woods, and my bet is they did not invite you to step on the green with him. He gets
the green. They get your green. The greatest marketing ploy that’s ever been seen!
There is currently no reason to believe that this will improve, or that actively managed mutual funds
as a group can ever outperform the stock market’s average returns. For that reason, investors who are
going to invest in mutual funds rather than in individual stocks should hold a very, very, very strong
bias toward investing in index funds (which invest across the board in a stock market index). But
index funds do the same as the market. So, you could just buy a Dow futures contract or S&P 500
and avoid all the sales costs!
$5 BILLION IN FINES TO THE MUTUAL FUND AND BROKERAGE FIRMS FROM 2003
THROUGH 2006!
If $5 Billion in fines to these guys does not convince you how stacked the deck, there is nothing I
can say. You stand a better chance with a pickpocket. At least you know he’s not there to help you.
You Are On Your Own

The way to investment success is to know more than the next guy, to avoid the hustles and play for
the long term, with short term decisions along the way. You have learned when to buy stocks and
you have learned the funds are not going to do you any favors. So now it’s time to teach you how to
chose the winners… to find success on your own!
Odds of Winning: 20%?
It is often said that 80% of mutual funds fail to beat the market as measured by the S&P 500. This
statistic, however, cannot be taken at face value. In many years, it’s true that 80% of funds under per-
form the market, but the exact percentage of low performers changes every year.
According to a study from Jeremy J. Siegel’s book “Stocks for the Long Run”, the number of funds
that - over 30 years from the 1970s to early 2000’s - outperformed the S&P 500, excluding fees,
varied between 10% and 85% from year to year. Between 1982 and 2003, there have only been three
years in which more than 50% of mutual funds beat the market! So, while it’s not technically ac-
curate to say that only 20% of funds outperformed the market, we can say that most of the time a
majority of funds will under perform.
The really bad news is that it’s not the same group of funds that win every year. In other words you
can’t buy fund XYZ and expect that their past performance will be repeated; the winning 20% varies
widely.
The Concept of Stock Selection
There are almost as many ways to select stocks as there are stocks. The more popular a method is,
the less likely it is to work ---- that has been a pretty good operating rule. The most popular way of
finding a stock to buy is… someone shines you onto it. Perhaps a broker touts it, or a fellow worker,
an associate or a running buddy. Many of these are profitable.
You may read an article --- or get spammed --- about some new innovation, or read of a fast growing
company in a sparkling new industry. Lot’s of these become big winners.
Another widely espoused way of finding stocks to purchase is to buy stocks of the companies whose
products you use. Coffee drinkers in the 1990’s made fortunes buying Starbucks; I bought $400
worth as a bat mitzvah gift for a neighbors daughter, now worth over $40,000. I was running mara-
thons in Reebok shoes back then as well and loved the new innovation they had developed. I bought
six or seven pairs of their new shoes… but not the stock.
You will always hear… and see in your own life… hot new companies as I have. You may want to
take a roll of the dice with one; fine. But those should not encompass your entire approach to invest-
ing, nor should they take up a serious part of your bankroll.
The great myth of Wall Street is that growth has special rewards. To really succeed you need to
“catch a high flyer.” That is the mantra of market pundits.
If you could catch all the high flyers, if you knew in advance what stocks these would be… and then
if you could get out before they crashed… it would be a great strategy. That is a strategy built from
looking backwards on an assumption of sand that you could ferret out such stocks. However, this
is no evidence the average guy, gal or mutual fund can accomplish, this high-wire walk over Wall
Street. Investing in high flyers usually results in Mike Tyson like body punches to our bankroll.
I was tempted to take a high flyer, Reebok. I liked the product, but the stock at that time was a ter-
rible selection as it sported low value, large debt, high P/E ratios etc. My point is that on any hot
tip you get for any flyer, first check out the value ratios you will learn next to confirm the stock is
worthy of speculation. The most important basic concept to understand in investing in stocks is
Stocks Create Lasting Trends Only If Earnings Increase

Stock Selection | 7
Ultimately Value Is Rewarded
These words are my mantra of investing; they are the milk and honey of long term market success.
Our problem is in identifying value and understanding how to determine earnings.
There Are ONLY Two Reasons a Stocks Goes Up
As near as I can tell, there are only two reasons for a stock to advance. The first is, the company
gains some type of popularity or notoriety. This is fodder for reports and stories of new prospects,
potential gains. People love new things, love innovations; investors are always looking for the
newest innovation in the marketplace on the assumption that will drive prices higher. Stocks have
rotated over the years... one year the drug stocks were in vogue and simply couldn’t go down. That
was until another group of stocks, the biogenetic ones became the darlings of the day. Then these
stocks gave way to computer chip manufacturers... and so it continues, there’s always one group of
stocks that just catches investors’ fancy.
These stocks go up because of stories and rumors and possibly even some form of manipulation,
which is not out of question in a free market system. When people are long stocks it is only natural
for them to want prices to go higher. Some people just may see if they can’t be part of that program
through a campaign of positive publicity, which may even deteriorate into an out and out touting.
Trust me, it happens. I’ve seen it... it takes place... I know it is not supposed to, but it does. There
are even legal forms of this. After all, corporations can run ads. Investors can have their brokers
call you up suggesting that you purchase stocks based on the stories they spin. Brokers make good
politicians, as they are wonderful “spin doctors.”
Spammers have perfected this in their manipulation of stock markets; these messages touting stocks
and shares can have real effects on the markets. A study recently published on the Social Science
Research Network stated their conclusions prove the hypothesis that spammers “buy low and spam
high.”
E-mails typically promote penny shares in the hope of convincing people to buy into a company to
raise its price.
People who respond to the “pump and dump” scam can lose 8% of their investment in two days.
Conversely, the spammers who buy low-priced stock before sending the e-mails, typically see a
return of between 4.9% and 6% when they sell.
The researchers say some 730 million spam e-mails are sent every week, 15% of which tout stocks.
Other estimates of spam volumes are far higher.
Mass Marketing
The study, by Professor Laura Frieder of Purdue University in the US and Professor Jonathan
Zittrain from Oxford University’s Internet Institute in the UK, analyzed more than 75,000 unsolic-
ited e-mails. All of the messages touting stocks and shares were sent between January 2004 and July
2005.
The e-mail messages had either been received by Professor Zittrain or been posted on a news group,
known as Nanas. Nanas is used to alert network administrators about new spam messages and the
action they can take against them.

The researchers were then able to compare the estimated size of an e-mail campaign with trading
activity and share prices immediately before and after the first arrival of a spam message.
The team found that a spammer who bought shares the day before starting an e-mail campaign and
then sold them the day after could make a return on his or her investment of 4.9%.
“If he or she were to be a particularly effective spammer, returns to this strategy would be roughly
6%”, they wrote.
Conversely, if someone who received the message chose to invest $1,000 in a promoted company
they would be left with $947.50 after two days.
Victims of a large e-mail campaign could be left with $930 after two days.
On average a victim loses $52.50 for every $1000 invested. However, real losses would be even
greater, the team suggest, because the victim would also have had to pay fees to buy and sell the
shares.
“Our analysis shows that spam works”, the team wrote. “Among its millions of recipients are not
only those who read it, but who also act upon it.”
Joshua Cyr, who runs the web site spamstocktracker.com, has performed an experiment by making
“virtual” investments in 1,000 shares after he receives a spam tip.
If his investment of more than $69,000 had been real, Mr. Cyr would have lost more than $46,000 in
15 months of following spammed stocks. Mr. Cyr says share prices spike and then drop, sometimes
by more than 90%, before companies realize they have been spammed!
Some companies have responded by changing their ticker symbols. Penny stocks are considered
ideal for spammers because they trade in low volumes, allowing a small amount of investment ac-
tivity --- spam’s --- to generate wild swings in value. This gives tipsters the greatest opportunity to
make a profit. Generally, they create excitement about a stock that they also invest in, then sell it into
the buying strength they created. That then sets off a wave of selling which eventually depresses the
share price.
Jonathan Lebed was 15 years old in 2000 when he began spamming stocks, and despite losing a law
suite for over $200,000, was not deterred. His mailing list today is estimated to be over 10,000 and
he is paid well (amounts up to $50K per month or more plus stock, etc) to hype these companies. He
sends out many e-mails each day. His e-mails move stocks.
Pump and dump has been the manipulators easiest game since stocks first began trading.
Everyone seeks the same outcome; then at some point, higher prices themselves become what is
driving the stock higher. A feeding frenzy has begun. The beasts feed upon itself! To the surprise of
classical economists, higher prices, which are supposed to deter or decrease demand, have in actu-
ality increased demand. Computer bells have sounded the alarm; the gargantuan momentum or up
move appears to be precisely a promise of profitable performance for the coming good years. Some-
times that scenario works out, at least for while, but most often what runs up like a balloon full of
hot air, falls once investors attention is turned in another direction or some pundit bursts the balloon.
Stock Selection | 9
That’s why stocks such as PriceLine.com could rally from $10 a share to $105 a share and back
down to $5 a share... and all in less than 15 months. This stock is not an exception... I have seen it
happen time and time again, which means it will happen in the future, many more times.
News stories, the great myth of a revolutionary new product or market, have driven up the price of a
stock. You should never under estimate the ability of news and greed to drive prices higher.
The Second Reason Stocks Advance

The second reasons stocks go up, and certainly the more stable one, is because the company is mak-
ing money. What a novel concept this is... make money and the price of stock goes higher! There
are several ways of looking at earnings’ ratios and that sort of thing, but one of the most significant
ways I think of using this is to see if the earnings are erratic or consistent. I’m certain you have fig-
ured it out; investors would prefer consistency that eliminates questions and fear of the future. The
market hates the unknown. It hates anything that is unreliable. So an erratic pattern of earnings may
occur in a stock that has a short-term rally, but this is not where serious and consistent (as well as
easy) money is to be made.
As go earnings, so go the prices of stocks. That is our mantra. Now... and forever. You can have
your choice, buy stocks that go up on the whims of news and stories or ones that go up based on
actual conditions.
It’s your choice, news or value? I have chosen value, as you will see. The mantra of value can be-
come a most valuable tool in helping us make our individual stock market selections. The all-time
great long-term growth stocks maintain their price advances, in just about every instance, only dur-
ing times when they were consistently profitable and were becoming more so every single quarter.
The great stocks of the past, when they did collapse, clearly started their declines about the time their
earnings started to decline. Thus, this is one of the most important facets of investing, one of the best
indicators we can follow.
Stocks for the Long Run

The mega fortunes on Wall Street have not come from day or ultra short term trading. The guys like
Buffet, Cohen, Cooperman and Lynch are not high frequency traders. There is an interesting study
done by the massive Fidelity Funds financial group. They are a fund manager as well as broker with
some 500 billion in assets. In a 2014 study they looked at their best performing customers account,
as well as the worst to see if there were things they could learn about success and failure.
Indeed there was! What they uncovered was that the accounts with the poorest performance
all had one thing in common; they were short term traders.
On the other hand the accounts with the best performance…were the ones of folks that had
forgotten the had fidelity accounts so did nothing at all…except ride the upward drift!
Barry Ritholtz, of Ritholtz Wealth Management, noticed something similar with families fighting
over inherited assets. Because of extended court battles, in some cases the accounts couldn’t be
touched for 10 or 20 years, the positions were frozen, locked out of in and out buying or selling.
What they found was that was the time when their investments performed best.
Warren Buffett stated it best, “Inactivity strike us as intelligent behavior, lethargy remains the corner-
stone of our investment style”.
Some groups of stocks have historically outperformed other groups of stocks. As an example, in an
energy dependent world, on average energy stocks have outperformed utility stocks. The following
clip from Credit Suisse gives a long range view (1900-2015) of group strength.
What an interesting perspective this is; Tobacco stocks have been the best performer followed by
Chemicals, Electrical Equipment, while shipping has been the laggard.
Chart 1: Stock Strength By Group
There are several ways you can, and should, incorporate this idea into your investing. One would be
to consistently be in the strongest groups, the other to be invested in what has become known as the
“Sin Stocks”, companies that deal in tobacco, gambling, booze and guns.
Stock Selection | 11
Chart 2, thanks to Credit Suisse, show the difference between investing in this “Sin” group vs the
greener Social Index of “ethical’ companies. Clearly, sin wins.
Chart 2: Sin vs Ethical Stocks
This holds true when we compare the winner sinners against the entire market as well as we see
when looking at the performance of the sin driven ETF; VICEX vs the market averages from Morn-
ingstar’s data.
Chart 3: VICEX Performance
This notion of sins stocks exists in all markets as you can see from this world wide view of sin
stocks. This investing concept should be part of your strategy. Noteworthy stocks would be Altria
(MO) tobacco, Constellation Brands (STZ) alcohol and Churchill Downs (CHDN) the Kentucky
Derby host with a collection of casino properties.
Chart 4: Annual Sin Stock Returns
Recent data from S&P Capital sheds a little more light on Sector investing with looking at selected
sectors current 5 year returns.
Chart 5: Investing By Sector

Leading the pack we see Consumer Discretionary stocks and Health Care. Fidelity has a nice tool
that allows us to blend %’s of various sectors to create a portfolio and look at the back test. In the
following test I was invested 50% in Consumer Staples and Health Care stocks. This group knocked
the socks off the market in general, showing is that sectors do matter.
Chart 6: 50% Consumer Staples 50% HealthCare

With all this in mind let’s look at some ways you can actually use this strategy. Chart 7 shows 4
asset classes we can invest in ala ETF’s. There are a few things to notice here. The massive 2008
bear market was not as devastating to the consumer staples and health care as it was to the market in
Chart 7: Consumer Staples & Health Care 2006-2015

general. When the Bulls resumed control of Wall Street, the overall market made new highs 2 years
later than did these sectors!
I see no reason why consumer staples and health, as groups, will falter in the future. I suggest you
look at how the average investor does vs the various asset classes. There sure is a lesson to be
learned here.
Chart 8: Average Investor vs Asset Class
MY BEST THOUGHT — I’ve had very few really great ideas in my life… and who am I to
judge… but if I ever had a good idea it was to realize that to beat the market is to beat, outper-
form, the market. That simply gets down to doing better than the average of the 30 stocks in
the Dow.
If that’s our only problem, the answer is simple. Just don’t buy a couple of the under performers.
BUY all of the rest in that list, and you AUTOMATICALLY BEAT THE MARKET.
Winners are hard to find, losers are so easy. Sidestep a few of those in the Dow, buy the rest and we
beat the market; year after year.
Knowing my goal is to do better than the averages, in my case the 30 stocks in the Dow Jones Indus-
trial Average, I realized it was most elementary; all I had to do was find one stock among those 30
that was a real turkey, pass on it like the plague. Buy the remaining 29 and I beat the market! Pretty
simple. If our long term goal is to nail down that 10.46 % gain --- or more --- instead of trying to find
the giants of tomorrow in a world of hype and rapid change, let’s just buy the averages, or part of
them, leaving out the toads.
It is so much easier to find the really stinky stocks to bypass. First of all, no one is trying to hype
them off on us and in a few seconds you can see if they have merit; are they making money?
Introducing the Darlings of the Dow Concept
My entire working thesis is to buy at the right time, as discussed earlier, the 5 best valued stocks in
the Dow Jones Industrial Average. I call these the “Darlings of the Dow.” We will spin them around
the dance floor for 6 to 9 months and then exit the ball room… someone else can have them in the
danger zone of May to mid October.
You could buy the 10 best, or 29 best, but most people don’t have that kind of money. So I have nar-
rowed it down to 5 stocks, something the average person can afford to do. With that as an outline,
I’d like to next teach you about finding value in stocks.
We have narrowed down (from the timing studies I showed you) when we will buy, and that we will
buy 5 stocks. Now begins the fun of selecting those 5 stellar performers. First though, here are some
dirty secrets about the Dow Jones Industrial Average you need to know.
What You Don’t Know About The Dow Will Shock You!
Sure, you know there are 30 stocks in the Dow. They are blue chips and many people think it’s im-
possible that a mere 30 stocks can represent the full market. Yet, look at a broader based chart, like
the Russell Index, or the instable NASDAQ, or the more stable S&P 500. You will see the averages
move pretty much in step with one another.
It did not begin that way though. The first Dow Average had only 11 stocks, mostly railroads, and
the hot stocks of 1884 when Charles Dow, a newspaper reporter turned market letter prognosticator,
formed the group.
By 1896 the list grew to 12 stocks by then, and none were railroads. You may recognize some of
those stocks from 107 years ago; General Electric, American Tobacco, and U.S. Rubber. As 1916
rolled around the list had grown to 20 issues. Then in 1928 it expanded to where it is today at 30
issues. The magic 30 issues have changed over the years; GE has been in an out of the Dow several
times. Over 20 of the companies in the average have been in business for more than 100 years. As I
tell people, these Dow stocks, “are not apt to Enron on us.”
Companies just don’t go bankrupt when they are in the Dow 30. Their CEO’s are not nearly as likely
to play games with their books… they are stewards to not only of family fortunes but history. Recent
additions to the list have been Walmart, Microsoft, Home Depot, Johnson and Johnson and Intel, in
the effort to have the index reflect the current economic climate.
As you can see, fortunately for us, the people at the Dow Jones organization delete turkey stocks
from the list and add new stocks. This means you don’t have to worry about selection in terms of
new industries or what company is representative of their technology… that is naturally done for you
with additions to the 30 industrial stocks (while deadwood is cut out and new wood is added to the
average).
That is a huge advantage, as it gives you the opportunity to catch a Microsoft early on in the game
and, as you will see from the strategy, will keep you out of the same stocks when it is not a good
time to be invested in them.
Another redeeming feature of this select group of stocks is they are not Johnny come lately, they are
seasoned. They have been around the track more than a few time and kept the pace.
The following study, although from the UK, make a good point about these ‘seasoned’ or well aged
stocks, that like with wine improve.
Chart 9: Stock “Seasoning” Returns

When an Average is Not an Average

The price of the Dow 30 is not a true average. It is a weighed average, and the weighting works to
our favor!
To arrive at the daily Dow close, the keeper of the numbers does not just add up the closing price of
all thirty stocks and divide by 30. Old Charley Dow played around with math a little as well as stock
prices. What it seems he wanted to do was create an index that was balanced, in his mind, by the
price of the stock. He was not satisfied with just an average price of the 30 stocks.
Far from it, what happens is the 30 stocks are given a weight --- BASED ON THEIR PRICE. This
is a price weighted average, with the highest priced stocks being given more weight. In most all
other averages the weighting is based on market capitalization. So a low priced stock with a large
cap (relatively speaking these days) would be given more weight than a higher priced stock with a
small cap. As you may recall, a few years back five large cap stocks accounted for about 90% of the
swings in the entire NASDAQ due to the cap weighting.
As an example of the differences in the Dow, a $25 stock will have a weight of about 1.99 while a
$130 stock will be given a weight of 10 within the average. That’s a whopping difference that works
well to our favor.
Where it Gets Interesting --- Math to the Rescue

Keep in mind, very few people beat the market, which is our only goal. Beating the market on a
consistent basis is huge. So few people or funds have done it, over the long haul, that the goal is not
appreciated as being as lofty as it is. In our endeavor to beat the market I will stoop to every trick in
the book to bolster our performance.
Follow along with me for a moment and you will be amazed at how much difference the Dow price
weighting can make in our attempt to beat the market. Let’s say we buy equal dollar amounts of two
Dow stocks, one we pay $25 for that has a Dow weight of 2 and another we fork over $90 for with a
weight of 7, and these are pretty close to current Dow weights, by the way.
OK, we buy and the market does its thing… our $25 stock goes to $27.50 (a 10% rally) while the
$90 issue slides 9 points to $81, losing us 10%, so we are even. But the Dow Jones 2 Average (I’m
using 2 stocks not 30 to illustrate my point) will be down 8.5% as the 10% drop in the $90 stock is
weighted by our friends at Dow Jones by a factor of 7. As an aside here, high priced stocks in the
Dow are the ones that tend to be overvalued, that’s why they are high.
As you can see we bought equal dollar amounts and broke even while weighted investors would
have been down while we were flat. Yes, this can work in reverse. If all the high priced stocks in the
Dow move up they will have the impact of a greater gain. The thing is though, as value investors we
shy away from high prices, knowing they are the ones most apt to tumble.
It’s easier to beat the Dow if you can select the lower price stocks in those 30 stocks and sidestep the
higher price issues that will decline or not rally as much as the lower priced issues. The lower priced
issues will outperform the averages. Do this and you will beat markets.
Stock Selection Techniques
If you are looking for a real, real simple and easy way of selecting your five stocks, then you need to
know about the Law of Square Roots.
Square Root Law and Low Price Stocks

Old timers know the importance of “The Square Root Law.” Well, it isn’t really a law, but it is a
great way to understand a concept. What it says is that stocks move in equal increments of their
square root. In other words, a $100 stock (square root of 10) will move to $121 (square root of 11)
as easily as a $4 stock (square root of 2) will move to $9 (square root of 3). Conceptually, it says
that low priced stocks move more than high priced stocks. Arithmetically, however, there is that
huge 21 point move versus a small 5 point move!
Check it out, a $4 stock moving one square root to $9 is up 125% while the $100 stock also moves
up one square root, but returns only 21%.
Can this possibly have application to investing? Oh, you bet. As simple as it is, it is one of the most
powerful facts of life in the stock market… one of the best investment rules you will ever learn.
Books and mutual funds have been crafted on the idea of buying low cap stocks, but low cap per-
formance is spotty and the appearance of success may be due more to survival of the fittest than any
inherent advantage to these stocks. Yet, that does touch on a point. Low cap stocks tend to be lower
priced stocks than the large cap issues. Therein may lay the answer as to why low caps appear to be a
better buy.
Low price stocks do perform better. The truth is low price stocks tend to have larger percentage up
moves than higher price stocks.
This may or may not be news to you but hold on. There’s a kicker in here though that you are prob-
ably not aware of. It’s more often that we see a $20 stock move up 2 points (10%) than we see a
$100 stock swing 10 points or 10%. While the percentages are the same, there’s something about
“point swings” that benefits lower priced stock holders.
The second truth, is that lower price stocks tend to have smaller percentage down moves than higher
price stocks.
When the bad times come (that’s what I am always the most concerned with) the low price stocks
seem to have more of a floor under them. It is not unusual at all to see an $80 stock cave to $40 and
move right back up to $80. In short, there is more downside draft to a higher priced issue than a
lower priced one.
Yes, $20 stocks can go to $10, but there are fewer examples of that --- in quality companies --- than
the other way around. The ultimate “floor” of value based companies --- zero --- is a lot closer to 20
than it is to 80. An important caveat here is to stay away from stocks selling for $15 or less. I have
no figures or research to back that up with, just my observation over the years that many, many junk
stocks run up to the $5 to $15 range and then tank back into obscurity.
This should not be our case, anyway, as we are dealing only with quality stocks… the Dow 30.
Proving The Point

I did a very simple test of buying the 5 highest priced stocks in the Dow the last week of October
and exiting them 3 and 6 months later. The average 6 month gain was 7.5% That’s not a bad show-
ing, especially when we consider the Dow itself from 1974 forward has averaged a 5.48% gain. In
part we did better than the average because we were not invested all the time and missed most of the
crashes. In this fashion buying the highest priced stocks actually beat the market!
And Now for the 5 Lowest Priced Stocks

My next test was to buy the lowest priced stocks in the Dow with the same entry and exit as above.
The only difference was the price of the stock… no fundamentals were tested.
This group averaged 18.03%, beating the dickens out of their higher price colleagues in
the Dow.
These low priced issues were up 140% more than the highest priced stocks in the Dow
and 228% more than the full Dow Jones Industrial Average.
There is almost an investment strategy here, buy the 5 cheapest Dow stocks and forget all rest the of
the poppycock.
However, I am haunted by studies of the 1929-1940 eras when just low price stocks did not fare as
well. Yes, I sure like low priced stocks, but above all I want to buy value. So the entire Darlings
search is about low priced stocks that have value added to them.
Typically Wall Street pundits will tell you that “low cap” stocks are the ones to buy. A “low cap” is a
stock that has a small number of shares outstanding; its capitalization as expressed by the number of
shares trading is small. Is this adage true? My following research gives us the answer.
As I hope you can tell, I take research seriously and in that process continually checked my studies,
to make certain we know what to rely on and what not to. One of the things that has been disturb-
ing to me is that --- so far --- all my studies have been done on a very exclusive group of stocks, the
Dow 30. For a moment I will turn your attention to the S&P 500, an average of 500 stocks, to see if
we have a confirmed premise.
5.6% PER YEAR DIFFERENCE BETWEEN LOW CAP AND HIGH CAP STOCKS
Talk about an easy to follow selection strategy; either buy the 50 stocks in the S&P (that’s 10% of
them) with the smallest market capitalization or buy the 50 highest cap stocks. Forget fundamentals,
forget price, and forget everything you think you know. Which is the best strategy? Just buy the low
caps... and you do better than buying the high caps.
The following set of charts shows the returns from buying on the first trading day of the year with a
3, 6, 9 and 12 month hold. Selection is based only on market capitalization.
Annual Return with Various Holding Periods

50 Highest Market Cap in S&P 500
14 12.38%
12
10
% Return 5.65%
5.11%
6
4
1.67%
0
3 Month 6 Month 9 Month 12 Month
Hold Period for Stocks
Chart 10: Highest Market Capitalization, Buy First Trading Day of Year

50 Lowest Market Cap in S&P 500
17.96%
18
16
14
10.46%
12 9.95%
10
% Return
8
4.52%
6
0
Holding Period for Stocks
Chart 11: Lowest Market Capitalization, Buy First Trading Day of Year
What we see is that the low cap stocks outperform the high cap stocks in the 500, just as they do
in the Dow 30. The low cap stocks produced an average annual gain of 17.9 % per year while the
large caps registered 12.3 % average annual gain.
The message is clear, low cap S&P 500 stocks are best. Just how great is the difference? A quarter of
a million dollars!
If, starting in 1976 you had invested $100,000 in the high 50 and let the money roll, at the end of
2004 you would have had $343,600 in your bank account to invest wisely on good women and bad
booze. Ten years and you tripled your bank account.
If, starting in 1976 you had invested $100,000 in the low 50 and let the money roll, your account
balance at the end of just 10 years would have been $634,828, a difference of $291,228. Imagine
that! Over a quarter of a million dollars more thanks to that little 5.6% percent year difference. Little
things can matter.
And Now a Look at Low Priced Stocks

The wildly popular Dogs of the Dow strategy consists of buying the lowest priced, highest yielding
stocks in the Dow. Could there be a better strategy than low price? I have found in the Dow that the
low cap stocks in that index outperform the low priced ones. Is that a fluke or a market fact of life?
To get to the truth I ran a test on the S&P 500, buying the lowest priced 50 stocks (10% of them) and
compare the returns against buying the 50 highest priced stocks in the S&P 500 to see, what if any,
difference there is in this strategy.
What I wanted to know first of all, is if the low priced stocks really do perform better than the high
priced ones. While our data only goes back 15 years the sample size is so much bigger than the Dow
30 that I think this study gets us much closer to real market truths.
Let’s start with a look at how the highest priced 10% of the S&P 500 have performed over this time
period. To their credit, they made money on balance, despite the 2000 - 2003 bear market.

50 Highest Priced Stocks in S&P 500
14.79%
16
14
12
10 8.15%
7.22%
% Return 8
6
3.62%
0
Chart 12: Buy Highest 10% Priced Stocks in S&P 500
The average annualized gain was 14.79%! Not bad when we consider the average annualized gain
for the 500 average of stocks was 15.25%… but the high priced issues could not beat the market
itself!
Now let’s see what happens if our only selection is to buy the lowest priced 10% of the S&P 500. No
other measure is used, just the price.
Our research reveals a dramatic difference; the lowest priced stocks chalked up much more impres-
sive gains with an average of 20.31%, that’s 5.5% better than the highest priced issues.
A side note here, the high flyers of the day that suck in the public and emotional players are almost
always found in the highest priced group… it is not a good bet. Consider this, in the year 2000 the
highest priced 50 were down 19.62% while the lowest priced 50 were up 15.47%. Makes sense, in a
bear market high prices tumble faster (law of the square root).
In this time period the highest priced group had four years of double digit gains, as did the lowest
priced group. There were incredible differences in the gains. The greatest double digit gain for the
top group was 13.5% while the lowest priced stocks saw years with a 42%, a 20%, an 18% and a
15% gain… low priced stocks perform better.

50 Lowest Priced Stocks in S&P 500
25
20.31%
20
15 12.50%
10.82%
% Return
10
6.36%
0
Chart 13: Buy Lowest 10% Priced Stocks in S&P 500
The Best of Both Worlds: Low Market Cap and Low Price
My next study was to screen for the 50 lowest priced stocks in the S&P 500, then from that group
narrow it down to the 25 smallest cap stocks; buy them with the same entry and exit used in the stud-
ies above.
I wanted to know if it was best to first look for low price or low cap in our screens.
The answer is not quite what I had anticipated. The difference in the results of these tests is not large
enough to paint a compelling picture one way or the other. Here, let me show you what I discovered.
Select The 50 Lowest Priced Stocks And Then From That Group Of Stocks Select The 25 Small-
est Market Cap Stocks
Vs
Select The 50 Smallest Market Cap Stocks And Then From That Group Of Stocks Select The 25
Lowest Priced Stocks
The best test results (with an average 12 month gain of 21.50%) came from the screen that first went
for the lowest market cap stocks.

25 Lowest Price Stocks of the 50 Lowest Market Cap Stocks
in S&P 500
25
20.4%
20
13.51%
15 11.98%
% Return
10
5.81%
0
Chart 14: Buy Lowest Priced Stocks of Lowest Market Cap

25 Lowest Market Cap Stocks of the 50 Lowest Priced Stocks
in S&P 500
25
21.51%
20
14.94%
13.74%
15
% Return
10 6.89%
0
Chart 15: Buy Lowest Market Cap of Lowest Priced Stocks

However, the other strategy was not far behind in results, that strategy being to use the first selection
screen of identifying the 50 lowest cap stocks and then selecting the 25 from the 50 with the low-
est price. This group averaged 20.4% per year, a scant 1.1% less than doing the test the other way
around.
BOTTOM LINE --- As I see it, one of the initial screens to find our Darlings, or any other group of
stocks, is to first select the lowest priced stocks, and then to begin to screen from there for market
cap, P/E ratios or whatever other criteria you want to use. But in any event, the simple screens of
low cap or price beat the market.
A last point: small cap stocks may not out perform large cap stocks!
Brokers and authors have bandied this about for years; their thinking is that smaller companies have
larger room for growth than the “mature” blue chips, like the ones in the Dow Jones Industrial Aver-
age. Virtually all of the studies show and prove this point. Investors Business Daily (IBD) is chocked
full of charts all showing, indeed, small cap stocks do better. Ironically, as I was writing this I was
looking at a fancy flyer from the mail from one Sharon Parker telling me, ‘SMALL CAPS EQUAL
BIG PROFITS” and adding, “top small caps were 39 times more profitable than the best blue chips.”
Wow, this small cap stuff is like shooting fish in a barrel; buy small caps and prosper. Can it be that
easy? If so, let’s have just a little taste of the proof of the pudding to make sure this is correct.
Now comes the “proof.” From Kiplinger data I draw these conclusions (Kiplinger did not draw any
conclusions… these are mine for which I am responsible).
In the last 10 years the average of all funds invested in high cap stocks have returned
8.2% per year and in the last 20 years have averaged 10.2% Funds invested in small cap
stocks have returned 8.1% in the last 10 years and 8.3% in the last 20 years.
That’s pretty chilling, the funds have not been able to milk this supposed advantage… they went to
the barn and came back with an empty bucket. This is largely due to the bias of the studies. They are
only on small cap stocks that survived. The ones that tanked, that we would surely have bought, are
not there to study as they went belly up. Lots of them do.
Perhaps small cap stocks look like they outperform large caps, but there is no evidence that the
“brightest and best” minds of Wall Street have been able to take advantage of that “fact.” If they
can’t, do you expect you or your broker to do better?
There you have it, the first step in a selection process, of understanding how to put the odds in our
favor. While most investors will be hashing out the ramifications of cash flow, momentum, return on
equity or arguing value vs growth, you now know one very hard market truth; low priced stocks out
perform high priced stocks.
With that in mind let’s turn out attention to the next critical point, “is it better to be a value or growth
investor?”
Value Vs Growth - The Answer?

The debate rages on as to what is the best selection technique to find winning stocks; value or
growth?
IT’S ALL ABOUT EARNINGS (GROWTH) INCREASES---REALLY?

Here are the annual out-performances/under performances of the Vanguard GROWTH Index Fund
(ticker VIGRX) and the Vanguard VALUE Index Fund (ticker VIVAX). VIGRX holds the stocks
in the S&P 500 that have above median price to book value ratios, and VIVAX holds the companies
with below median price to book value ratios.
Vanguard Value vs Vanguard Growth 1998 - 2005

Year VIVAX (Value) VIGRX (Growth)
1998 -13.9% 13.6%
1999 -8.5% 7.7%
2000 15.2% -13.1%
2001 0.0% -11%
2002 1.2% -1.6%
2003 3.6% -2.8%
2004 4.4% -3.7%
2005 2.1% -0.7%
Table 5: Vanguard Value vs Growth
On average, value (VIVAX) outperformed the S&P 500 by 0.5% per year, with t-score 0.2 and
growth (VIGRX) under performed by -0.2%, with t-score -0.1. What we have here is a statistical
dead heat!
(By the way, if you were wondering what 2006 looked like: VIVAX 6.4% and VIGRX -6.8%)
Before I wade in on the subject I’d like to introduce you to Tim Melvin, vice president of invest-
ments with Ferris, Baker, and Watts in Annapolis, MD, who has some very strong views based on
his research (which includes the study above) and hands on investing regarding the value vs growth
argument. Here are his comments:
“Now we come to yet another very uneven comparison technique... we take Value Line... the single
highest performing growth stock newsletter... that screens all the stocks with growth characteristics
down to the 100 ‘Value Line Growth Stocks’ (VLGS).
A fair comparison would be to compare VLGS to the best value managers... and here my friends it
is not even close. According to an article on the VL web site, the VL out-performance by #1 ranked
stocks is some 2.5 points over the market.
Looking at the best value funds over the same time, we find that the FPA Capital Fund, run by the
incomparable Bob Rodriguez outperforms by over 6 percentage points in the same time frame. As-
set conversion king Marty Whitman’s 3rd Ave value fund does so by 3.5...so on a best versus best
basis... value outperforms VLGS... keep in mind also the Value Line study is without taking into
account commish or fees.
(Value Line does not live in the real world... not only do they fail to deduct fees they assume you can
buy all their stocks and roll in and out of the stock once, getting excellent fills that are often not pos-
sible after their reports go out. Indeed, Value Lines Fund performance of Growth Stocks has never
matched the claimed performance of their number one stocks.)
Now a more direct look at the AVERAGE FUNDS (real time performance) of each style... I am us-
ing Morningstar data for the past 5 and 10 years.
Morningstar Value vs Growth as of 2006

Approach 5 Years % 10 Years %
Small Growth 8.35 10.01
Small Value 1.98 13.69
Mid-Growth 5.15 10.06
Mid-Value 8.36 13.31
Large Growth -1.31 9.18
Large Value 1.85 10.90
Table 6: Morningstar Value vs Growth
Using a more fair comparison method... best value versus best growth and average value versus av-
erage growth, instead of best growth versus an unmanaged screen of characteristics.
Value stocks beat growth stocks over all time periods.
To continue to present the value line MANAGED portfolio against an unmanaged bottom decile of
price to book is the most uneven and unfair comparison I have ever seen. Whitman, Browne and
Rodriguez have KILLED Value Lines performance by significant percentages.
The God of Growth Fisher, as much as Graham is the God of Value, only bought growth when it
stumbled and was cheap. Munger as growth oriented as he is, is price sensitive. The best value
guys beat the best growth guys EVERY time. Bob Rodriguez or Chris Browne have delivered un-
levereged 15 percent plus returns... no options, no futures, just stocks... for decades
The best traders make more money than the best investors. It’s a fact.
A good trader will outperform growth, value and everything in between. Great traders
win this game… period. But, it has NOTHING to do with growth versus value. If you
bought the best growth stocks in 1971... YOU ARE STILL NOT EVEN.
Done correctly, value investing is buying growth companies at cheap prices due to economic or com-
pany specific difficulties. Lakonsihok and Vishey and LSV investments, their management firm, are
knocking the cover off the ball with this approach.

Best value guy against Best growth guy? Bring the battle on... value wins every time.
I’ll be the first to admit that best TRADER tops all. But buying momentum growth stocks is equal to
investing suicide... The current guru of growth, William O’Neil; saw his fund busted out in the 90’s...
the best growth market in history.”
Tim mixes no words, and deftly touches on an important point when he said the approach is to buy
growth companies --- at cheap prices --- value! This is the cornerstone of the Darlings of the Dow
Strategy... value stocks that have been making money.
I have shown that growth, ala price or earnings increases are not enough. Below are some of the
highlights of my research concerning the various ratios the Street is so infatuated with. The data here
was from 1975 through 2001 on just the Dow 30 stocks.
The information above may seem outdated to you after all it is through 2005. Did that hold true in
the future is the question you’re probably asking yourself.
In fact it did if we look at the Vanguard spliced growth fund from its inception in 1992 we see that it
has had a 9.44% annualized rate of return. Certainly far better than you would have done with your
money in banks or bonds. The question is however can value possibly be growth? And the answer
continues to be yes it can and it does. The Vanguard spliced growth fund since its inception in 1996
has had a 10.98% return.
Year in and year out there is not that much different between growth and value funds but on a long-
term basis value continues to win which is interesting in light of the fact that most people think of
growth will win the race that just isn’t so
An important study I did was of buying stocks in the Dow 30 based on earnings increases. The
study gets right to the truth of the matter and the data is most illuminating.
I bought the 5 Dow stocks the last week of October each year, with the largest increases in earnings
over the prior 3 and 5 years. They were held, no stops, for 6 and 9 months then pitched. Here are the
results.
5 Dow Stocks With Greatest Gain In Earnings

Hold Period Over Prior 3 Years
6 Month 5.1%
9 Month 8.8%
6 Month 5.3%
9 Month 11.1%
Table 7: Buy Largest Increase in Earnings 1975 - 2001
Next, let’s look at the five stocks with the smallest increase in earnings... these are the companies
that have had the poorest earning growth of all 30 of the Dow... we are not looking at price momen-
tum in these studies but earnings growth, or lack of it as in the numbers below.
5 Dow Stocks With Smallest Gain In Earnings

6 Month 1.6%
9 Month 9.3%
6 Month 3.8%
9 Month 10.1%
Table 8: Buy Smallest Increase in Earnings 1975 - 2001
There seems to be no great advantage to buying the stocks in the Dow with the greatest increase in
earnings based on the last three or five years.
The only difference between the two groups seems to be that on a six month hold the “growth” is-
sues seemed to fair better. Yet, hold another three months and it’s a wash... and not superior to all of
the value measure I have tested.
Now, to put this into perspective we need to see how these numbers stack up against the same strat-
egy applied to the total of all 30 stocks in the Dow. In this manner we can see how much better, or
worse, such measures of future performance are in comparison to the total sample.
All 30 Dow Stocks Regardless Of Earnings

Hold Period Avg Annual Return
6 Month 4.8%
9 Month 9.98%
Table 9: Buy All Dow 1975 - 2001
Why is this and how can it be... that while earnings matter... no earnings and stocks tumble, yet earn-
ings alone do not assure us of higher prices? Years before Freddie Mac was rocked by an accounting
scandal, billionaire investor Warren Buffett got on the phone with Freddie Mac chairman Leland C.
Brendsel and explained why he was selling shares of the giant mortgage funding company.
Brendsel had made pledges about earnings growth at Freddie Mac, and Buffett was apparently wor-
ried about where such promises might lead.
“All my history is that all institutions that have a primary goal of earnings growth get into trouble,”
Buffett said, according to notes that Brendsel made of the conversation. “I’ll never know when it
happens until it’s too late,” said Buffett, whose Berkshire Hathaway was one of Freddie Mac’s big-
gest shareholders.
Warren may have nailed the issue... that a focus on just increased earnings creates problems because
at some point the rate of growth cannot be maintained and that brings out the sellers. Growth is
needed, but not at the expense of value; value is a stable commodity. Growth, as Buffett pointed out,
is volatile.
Looks pretty clear to me. Just increasing earnings does not bring much to the table in helping us
select stocks in the Dow for superior market action... in other words to find the winners we have to
look at more than just the growth of earnings... we must find absolute value.
What We Have Learned So Far Is That Low Priced And Low Cap Stocks Are Most Apt To Outper-
form The Market
And
Stocks Selected Based On Value Measures Will Do Better Than Stocks Selected On Growth Mea-
surements
The Primary Measurements of Value
The following are typically used as the primary measurements of value:

Debt
Price To Earnings Ratio
12 Month Forward P/E
Earnings Per Share Growth Rates
EBIT
Cash Flow
Price To Book Value
Price To Sales
Dividend Yield
Net Working Capital
Return On Equity
Profit Margins
I have researched all of these measurements - and a lot more - but will not bore you with the details
of the research, as many of the supposed ratios did not prove helpful. Instead I will cut to the quick,
showing you the best measurements I have found to determine stocks that have the best advantages
of rallying.
Debt
The most basic measurement of value in the corporate world is debt; it waters down value to the
point of no return. So let’s begin with a look at the impact of debt on stock prices.
“You can’t build a growth company without debt” some say, while others admonish that “high debt
stocks are a sure fire way to low market returns.” I hope to establish, once and for all, the truth about
debt and stock market performance.
How Do We Measure Debt?

Classically, a wet behind the ears MBA guy or gall will tell you that the best way to measure debt is
to look at the ratio of debt a company has to its equity. For those not familiar with that ratio, below
are the details.
Calculating Debt-to-Equity
The debt-to-equity ratio offers one of the best pictures of a company’s leverage. The formula is
straightforward:
TOTAL LIABILITIES DIVIDED BY TOTAL SHAREHOLDERS’ EQUITY
Quite simply, the higher the figure, the higher the leverage the company employs. Notice that this
ratio uses all liabilities (short-term and long-term), and all owner’s equity (both invested capital and
retained earnings).
What it Means
Let’s say a company has long-term debt of $10 million in the form of a bond outstanding and equity
of $10 million. The debt-to-equity ratio is 1 (10/10 = 1). If the same company has the bond outstand-
ing and only $1 million in equity, then the debt-to-equity ratio is 10 (10/1 = 10).
This company is probably in big trouble. Alternatively, if the company has the $10 million bond
outstanding and $20 million in equity, giving a debt-to-equity ratio of 0.5, investors can feel a little
bit more comfortable. We can interpret a debt-equity ratio of 0.5 as saying that the company is using
$0.50 of liabilities in addition to each $1 of shareholders’ equity in the business.
Granted, a company with no debt may be missing an opportunity to increase earnings by financing
projects that will give a better return than the cost of the debt. A little debt can be good for a com-
pany’s earnings. On the other hand, a high debt-to-equity ratio translates into higher risk for share-
holders since creditors are always first in line for compensation should the company go bankrupt.
Shareholders must wait at the back of the queue for dibs on assets.
In the big picture, the debt-equity ratio tells us that debt isn’t bad, as long as there is a sufficient
amount of equity. When an investor buys equity it reflects positively on the company’s outlook. On
the other hand, it’s a bad situation when a company can only raise money by issuing debt.
Debt in the Dow

Debt has separated the winners from the losers in the Dow 30 rather well. The following results are
from buying in late October with three different hold periods.
In the last 30 years the average return of the highest debt to equity stocks has averaged 7.36%.

5 Highest Debt to Equity Stocks in Dow
7.36%
8
6
4.51% 4.40%
5
% Return
4
0
3 Month 6 Month 9 Month
Chart 16: Buy Highest Debt to Equity
The return on the lowest debt to equity stocks has been 11.69%. In short, these stocks have gained
58% more than the debt ridden companies.

5 Lowest Debit to Equity Stocks in Dow
11.69%
12
10
8
5.94% 6.06%
% Return
6
0
Chart 17: Buy Lowest Debt to Equity
Clearly debt is a burden to stock market performance and despite what you are told in business
classes, debt is not a good foundation to build your rock upon.
As a personal aside here, the worst years of my financial life were when another fellow and I bought
a bank, with debt, and a medical company, with debt. It was a truly horrible time that came close to
killing us both. It really got down to this; our dreams of the future revenues of this business never
matched the cost of running them and the cost of debt. The spread never improved.
This does not happen just to guys like me... why are the United States’ airlines in such financial
shambles? Huge and gargantuan debt? When I first reviewed this study, I was flying on Madrid Air
from Madrid to Buenos Aires. I was in first class where a round trip ticket was about $1,700 USD.
American Airlines wanted $4,500 for the same 12 hour flight. They had debt to pay, so they had to
charge more.
The one thing I learned from sitting on the board directors of the bank was that the money we loaned
people seldom solved problems or enabled growth. Debt tore people and businesses down.
It was such a black and bitter situation that I swore I would never have any debt in my life, ever-
again. If I couldn’t pay cash, I couldn’t have it. These days, I may not have all the trinkets my
neighbors have, but I know I sleep better. Yes, I have short term debt, like credit cards but those are
always paid off before interest kicks in. So there is no debt carried on them. I have seen so many
people destroyed by debt that I decided to see if I could live without it and... guess what? You can.
If I can do it, you can do it... debt is a temptress to buy stuff and the “stuff” that really matters in life
is not “stuff” anyway.
In recent years a better ratio to measure debt has developed.
EBIT
“EBIT, EBIT, EBIT” that sounds more like the start of a frog joke. In reality, it is the acronym for
a better way of measuring the amount of debt a company has. This ratio is used to determine how
easily a company can pay interest on its outstanding debt. It is calculated by dividing a company’s
Earnings before Interest and Taxes (EBIT) of one period by the company’s interest expenses of the
same period.
In this fashion, we are looking at how easily the company can service the debt. It is a superior ratio
for one simple reason; this ratio looks at the actual inflow of money coming in pre tax and interest
costs that are in the pipeline that might be used to pay off the bankers.
The reason this ratio works so well is that it looks at cash flow, monies actually available to pay the
tune of the pipers.
Our final clincher with it is that it is precisely these funds that a company will have available, gener-
ally speaking, to service debt. Which means we can make some powerful forward looking assump-
tions about “what if” scenarios, such as “what if” interest rates skyrocket?
Let’s say we know at current rates, of say 4%, a company that has debt of $5,000,000 will have to
pony up to the creditors $200,000 in debt service. Assume for this discussion that the company’s
EBIT is $400,000. Then they are well in the black.
However if we believe interest rates will double in the next year to 8%, suddenly under that scenario
the only pigs to be fed at the corporate trough are the creditors. There will be no money left over for
research, marketing, dividends etc.
Market history bears this out. The years that the low EBIT stocks (those with a low cash flow vs
debt) do the worse are the years that interest rates rise. A case in point is that in the last 30 years, the
worst performance of buying the 5 lowest EBIT stocks in the Dow was 1981. That was a time of ris-
ing rates and a 32.7% decline in these stocks.
By the same token, the best performance of this group was in 2002, a time of lower rates and a
42.5% gain in these low EBIT stocks.
Equally fascinating is the high EBIT stocks, those with large cash flows to pay debt. These stocks
actually eeked out a gain in 1981 of 2.3%. In short, while the bear stalked Wall Street, his easiest
road kill was a high EBIT stock.
IT’S ALL ABOUT TIME
Over time, the difference in these stocks becomes quite large. The following clip shows the year by
year performance of the five low EBIT in the Dow, then the highest five EBIT stocks.
The following chart reflects the performance of companies that have large debt vs their ability to
service their debt. Next we see how the “well endowed” Darlings performed.

5 Lowest EBIT Stocks in Dow
6 5.07%
3.64%
% Return
2 1.19%
0
Chart 18: Buy Lowest EBIT

5 Highest EBIT Stocks in Dow
11.23%
12
10
% Return 5.06%
6
4.02%
0
Chart 19: Buy Highest EBIT

The low EBIT stocks, over the last 30 years have eeked out a 5.07% rate of return, a return less than
the Dow itself.
This was a much better screen to find the poorer performing stocks in the Dow, as the high debt to
equity ratio stocks averaged 7.36%. Sure they were Dogs, but the real disasters were the high EBIT
stocks… these are to be avoided like the avian flu.
An investor who would have purchased just the five highest EBIT stocks at our Darlings’ entry point
would have averaged 11.23%... the difference is a staggering 125% greater return with these low
debt companies.
Improving on EBIT
We can use some ‘tricks of the trade” we already know to improve the performance of the low EBIT
stocks. Here’s how we can first screen for the highest ten EBIT issues, then select five from there
based on other measures such as market cap, price and price to sales.
HIGH EBIT/LOW MARKET CAP
In this study I first found the 10 best EBIT stocks and then “bought” the five with the lowest market
cap. This was based on the theory that low cap stocks in the Dow do a little better than high cap
stocks.
Such a screen did in fact improve performance, but not much; the net average annual gain was
boosted to 12.6%, about 1.5% better than just the low EBIT ratio.

5 Lowest Cap Stocks of the 10 Highest EBIT Stocks in Dow
14 12.63%
12
8.76%
10
% Return
6
3.60%
3.19%
4
0
Chart 20: Buy Lowest Cap of Highest EBIT

HIGH EBIT/LOW PRICE

In the next study I did the same as above, but I purchased the lowest priced stocks of the ten highest
EBIT. This idea is base on the Law of Square Root you learned earlier.

5 Lowest Priced Stocks of the 10 Highest EBIT Stocks in S&P 500
15.47%
16
14
11.26%
12
10
% Return 8
5.39%
6
3.66%
0
Chart 21: Buy Lowest Priced of Highest EBIT
HIGH EBIT/LOW PRICE TO SALES

In the next study, I did the same as above but purchased the five stocks with the lowest price to sales
ratio from the ten highest EBIT screen. This idea is based on an incredible amount of research on
this measure in order to select stocks that beat the market.
That selection helped quite a bit taking performance from 11.2% up to 15.46%.

5 Lowest Price to Sales of the 10 Highest EBIT Stocks in Dow
15.41%
16
14
11.19%
12
10
% Return 8
5.52%
6 4.47%
0
Chart 22: Buy Lowest Price to Sales of Highest EBIT
So while this strategy sure beat buying just the low EBIT stocks, it produced results similar to the
“low priced only” portfolio.
What we have learned is that debt really matters in the Dow 30, and it’s a great screening tool.
As the great Bard admonished us, “Neither a borrower or a lender be, for both shall dull the edge of
husbandry.”
Price to Book - One of Ben Graham’s Favorites
Old Benjamin Graham, a shrewd fundamentally --- value driven --- investor favored the price to
book ratio. For those unfamiliar with the ratio, it measures the total capitalization of the company
divided by the book value or net assets minus liabilities.
MORE REVELATIONS ON THE RATIOS OF INVESTMENT SUCCESS---All stocks are not
created equally. In fact the subtle differences in the financial strength of the companies can make a
huge difference to hopeful investors.
The conventional wisdom is that the higher the price to book ratio, the better a buy the company is.
Why? Because if all the assets were liquidated tomorrow, there would be plenty of cash to pay off
the holders of corporate stock. Perhaps when Graham was cutting his teeth on this stuff, in the
1930's and 1940's some say, the ratio meant more than it does now.
Let’s take a look. The following data reflects the average 6 and 9 month hold returns for purchasing
the low price to book vs the high price to book.
5 Lowest Price to Book in DJIA Portfolio

Dates 6 Month Hold Return 9 Month Hold Return
1975-2005 14.297 % 14.177 %
5 Highest Price to Book in DJIA Portfolio

1975-2005 12.076 % 18.008 %
The results reflect a test that buys the 5 highest prices to book stocks in then Dow Jones Average
from 1975 through 2002. If you had held these stocks for 6 months the average gain was 14.297,
holding for 9 months was not quite as profitable with a 14.177. This sure looks good, and we are
exposed to risk only 6 to 9 months. But if you are like me, you'd like to know how this relates to the
other ratios, and is there a better one! The best of this is the high price to book with a 9 month return
which results in over 18%.... Old Benjamin was right.
Cashing in on Cash Flow
Let's take a look at another measure of value so we can compare to see how good the price to book
ratio might be. The next clip covers the same time period, but this time we will use the Cash Flow
ratio. Graham was also an advocate of this measure of value which represents total capitalization of
the company divided by the 12 month cash flow of the company.
5 Lowest Cash Flow in DJIA Portfolio

1975-2005 12.24 % 13.84 %
5 Highest Cash Flow in DJIA Portfolio

1975-2005 12.62 % 17.26 %
The cash flow ratio is not quite as good on the 6 month hold with a 12.6% average gain, yet beats
the lowest price to book ratio with a 9 month hold return of 17.2%. That may not seem like much,
a meager 3% a year gain more than the price to book selection, but it makes a huge difference for a
long term investor.
The bottom line of these two ratios is that Cash Flow IS NOT QUITE AS GOOD AS PRICE TO
BOOK. So let's look at the other most widely followed fundamental factors, yield. Yield is how
much the company pays you in dividends for buying their stock. To arrive at the yield simply divide
the dividends by the price of the stock, your investment, and you have the yield.
Yield; The Right Way?
Dividend Yield has been the focus of many investment “systems”, most notably one called the “Dogs
of the Dow” that focuses on the 5... or 10... stocks in the Dow 30 with the highest yields.
The Dow Jones Industrials represent an elite club of thirty titans of industry such as Exxon, IBM,
GM, DuPont, Philip Morris, and Proctor & Gamble. From time to time, some companies are dropped
from the Dow as new ones are added. By investing in stocks from this exclusive list, you know
you're buying quality companies. The idea behind the "Dogs of the Dow" strategy is to buy those
DJIA companies with the lowest P/E ratios and highest dividend yields. By doing so, you're selecting
those Dow stocks that are cheapest relative to their peers.
So here is the Dogs of the Dow strategy in a nutshell: at the beginning of the year, buy equal dollar
amounts of the 10 DJIA stocks with the highest dividend yields. Hold these companies exactly one
year. At the end of the year, adjust the portfolio to have just the current "Dogs of the Dow." What
you're doing is buying good companies when they're temporarily out of favor and their stock prices
are low. Hopefully, you'll be selling them after they've rebounded. Then you simply buy the next
batch of Dow laggards.
Why does this work? The basic theory is that the 30 Dow Jones Industrial stocks represent well
known, mature companies that have strong balance sheets with sufficient financial strength to ride
out rough times. Some people use 5 companies, some use 10, some just one. You might call this a
contrarian's favorite strategy.
A 12/13/93 Barron's article discussed "The Dogs of the Dow." Barron's claimed that using this
strategy with the top 10 highest yielding Dow stocks returned 28% for 1993, which was 2 times the
overall DJIA, 2 times the NASDAQ, 4 times the S&P500 and better than 97% of all general US eq-
uity funds (including Magellan). In the last 20 years, this strategy has lost money in only 3 years, the
worst a 7.6% drop in 1990. In the last 10 years, it has returned 18.26%.
Merrill Lynch offers a "Select 10 Portfolio" unit trust, which invests in the top 10 yielding Dow
stocks. Smith Barney/Shearson, Prudential Securities, Paine Webber, and Dean Witter also offer it. It
has a 1% load and a 1.75% annual management fee, and they are automatically liquidated each year
(cash or rollover into next year, but capital gains are realized/taxed). Minimum investment is $1,000.
THE BAD NEWS --- The strategy has lagged the market in recent years. In the 10 years through
2006, Dow dogs gained 8.8% compared to 10% for the S&P 500 and 9.9% for the Dow.
The erratic performance of the Dogs on recent years (our Darlings have always outperformed the
Dogs) comes as no surprise based on my research. Here’s what our research shows about the high
yield stocks from data thru 2005.
5 Highest Yield in DJIA Portfolio

1975-2005 13.098 % 16.798 %
5 Lowest Yield in DJIA Portfolio

1975-2005 14.31 % 15.218 %
As popular as the Dogs have been, the hit and miss performance has not stopped the popularity of
the approach. Yet, as you can see from what you have learned so far, there are numerous measures
and approaches you have already learned that outperform a yield based investment program.
Notes on Yield Investing

Many of us invest more for yield than immediate return. The problem in this arena is how to know if
the company you are investing in will continue the attractive dividend. Here are some answers that
also help those who follow the “Dogs of the Dow” strategy and want to weed out companies that
may cut back or stop paying dividends.
MORE INVESTORS ARE PAYING MORE ATTENTION TO COMPANIES PAYING HIGH
YIELDS
The recent tax cut on dividends has turned many investors to yield investing. In the past, Uncle Sam
taxed dividends at an investor's marginal rate (as high as 35%). Now they are taxed at a maximum
of 15%, the same as capital gains rate on profits from the sale of a stock you've owned for a year or
more. That goes a long way toward, putting dividends on equal footing with capital appreciation.
Most companies that pay dividends also have dividend-reinvestment plans (DRIPs), which let you
reinvest your payouts in shares of stock without paying a broker, thus pinching a few more pennies.
CASH IS KING FOR DIVIDENDS
If you are a yield investor make sure the company has plenty of cash on the books and that the divi-
dend is coming from excess cash flow. The key here is excess cash flow. So after shareholders are
paid, there is still money left for capital spending and things like acquisitions, research and develop-
ment, or share buybacks.
You can tell how much cash a company is using to cover its dividends by looking at the payout ratio,
or the percentage of earnings paid out in dividends over time. This will greatly help in avoiding com-
panies that may shut down the dividends.
HIGH YIELDS CAN MEAN HIGH RISK
It's the extremes that you want to avoid. If a stock pays a sky-high dividend, it’s usually a red flag.
For example, non utility stocks that yield more than 5% (divide the annual dividend by the current
share price to get the yield) may mean the companies are in distress or in risky turnaround situations.
Be confident that a high yielder is generating enough free cash flow (cash left over after expenses,
interest, taxes and capital expenditures needed to maintain the business) to pay the dividend. Oth-
erwise, it may have to cut its payout or dip into previous years' profits to cover it... and not pay you
what is “rightfully yours.”
A Look at Net Working Capital
The Graham Dodd School of Investing often refers to Net Working Capital as an important consid-
eration of stock selection. This is defined the same as working capital - total current assets less total
current liabilities. Others refer to it as the Current Ratio.
Working capital is used by lenders to help gauge the ability for a company to weather difficult finan-
cial periods. Working capital is calculated by subtracting current liabilities from current assets. Due
to differences in businesses and the fact that working capital is not a ratio but an absolute amount, it
is difficult to predict what the ideal amount of working capital would be for your business.
To calculate working capital requirements we use the “Current Ratio” to determine a target amount
of working capital. Old Ben Graham liked this approach, telling us to “buy a group of stocks selling
at less than their working capital ratio.” He expected such stocks to “afford the investor an average
annual return of between 12% and 15%.” The following data reflects a study I performed on the
Dow Industrials from 1975 to 2003, looking at buying the 5 highest net working capital stocks in
the last week in October and exiting on April 15th. We also tested buying the 5 lowest net working
capital stocks in the last week in October and exiting on April 15th. That’s 28 years of data to see if
this ratio has meaning and impact on future stock prices.
5 Highest Net Working Capital DJIA 1975-2003 Annual Return 9.1%

5 Lowest Net Working Capital DJIA 1975-2003 Annual Return 13.8%
These results are the exact opposite of what one would have expected; the companies with the lower
net working capital actually outperformed the ones that were supposed to be more fundamentally
sound! This is not unusual, in my studies, to see that the lore of the Street is not backed up by actu-
ally looking at the data. By the way, it also appears this ratio is of not much help in that the highest
return, 13.8% is pretty lackluster when we see that this value is bettered by high yield stocks, low
price to book stocks, and low P/E stocks.
In summation, I think it’s safe to say what we have here is a ratio we don’t need to consider any lon-
ger, and can discount advisors and such that tell us of its’ power. Knowing what not to know can be
as valuable as knowing what to know!
Return on Equity
ROE, ROE, ROE You’re Stock, Gently Down The Stream
ROE, or Return On Equity is supposed to be one of the “quickest ways to gauge whether a company
is creating assets or gobbling up investor’s cash” and “knowing the company is generating assets on
invested capital rather than burning thru it is a great starting point” to find a winning strategy, or so
say the folks at ZACKS research.
ROE is a company’s income divided by the common equity; a ROE of 15% means 15 cents are cre-
ated for each shareholder dollar that was originally put up.
A Dose of Reality
Despite what you have read, the facts do not support ROE as a superior measure of value, or at least
a value measure that has the ability to beat the market.
I say this based on my study whereby I used a model of buying the lowest 50 ROE stocks in the S&P
500 on January 1st of each year, and then holding for the entire year with an exit on the last day of
trading.
I only have data back to 1990. Still though, I think the last 15 years of market action is a large
enough sample to get a decent idea of what works for superior stock selection.
In the last 15 years the investment strategy I just described above (buying highest 50 ROE stocks)
applied to all stocks in the S&P has returned 15.25% a year.
What we have here is a bench mark, the market itself, to compare our various strategies against to
see how good or bad it is.
Now, when it comes to testing the 50 stocks with the LOWEST ROE we get back some very intrigu-
ing data... they do better than the market itself. Strange but true, this group returned 16.21% per year
on average during the last 15 years. They beat the market, sure, not by much, but they outperformed
the other 450 stocks!
The first clip shows the annual return from buying the 50 stocks with the lowest ROE. If the theory
of ROE investing is correct we should find this group of stocks to seriously under perform the mar-
ket itself. Here we buy the 50 lowest ROE stocks in the S&P 500 on Jan 1.

50 Lowest Return on Equity Stocks
in S&P 500
16.21%
18
16
14
12
8.30%
10
7.34%
% Return
8
6
2.87%
4
0
Chart 23: Buy Lowest Return on Equity
The Other Side of the Coin
My next run through the data was to set up the same buy time period, but select the 50 stocks in the
S&P with the highest ROE. These are the ones that ZACKS claim present investors with the best
opportunity for being big winners.
That’s what they say, but it is not what the data says. In fact the 50 highest ROE stocks did do bet-
ter than the market netting an average annual gain of 17.56%, but only 1.36% better than the lowest
ROE stocks. In my opinion this data it is not persuasive enough to seek out just high ROE issues.
There is not a wide enough gap here between the high and low ones, and the results are not wildly
different from the market.

50 Highest Return on Equity Stocks in S&P 500
17.56%
18
16
14
12
9.66%
8.70%
10
% Return
8
6
3.56%
0
Chart 24: Buy Highest Return on Equity
Making it Better...
What we have learned is that the lowest priced stocks in the S&P 500 outperform the others. So, it’s
a natural step to inquire what happens when we combine high ROE stocks with low priced ones?
I thought you’d like to know, so I did the tests and this is what I uncovered with the various screens:
Finding the 50 lowest return on equity stocks then screening for the 25 lowest priced stocks resulted
in a 19.3% 12 month gain.
Finding the 50 highest return on equity stocks then screening for the 25 lowest priced stocks resulted
Finding he 50 highest priced stocks then screening for the 25 lowest return on equity stocks resulted

25 Lowest Priced Stocks of the 50 Lowest Return on Equity Stocks in S&P 500
19.30%
20
18
16
14
12 9.99%
9.27%
% Return 10
6
3.30%
0
Chart 25: Buy Lowest Priced Stocks of Lowest Return on Equity

25 Lowest Priced Stocks of the 50 Highest Return on Equity Stocks in S&P 500
25
20.40%
20
15 12.21%
11.34%
% Return
10
4.80%
0
Chart 26: Buy Lowest Priced Stocks of Highest Return on Equity


25 Lowest Return on Equity Stocks of the 50 Highest Priced Stocks in S&P 500
14 12.30%
12
10
7.48%
7.24%
8
% Return
3.23%
4
0
Chart 27: Buy Low Return on Equity of Highest Priced Stocks
It looks like a broken record in that there is very little difference between high and low return on
equity stocks... and that the low priced criteria makes a huge difference. For certain the combination
of high priced and low ROE is one to avoid.
Taxes and Stock Market Performance... The ‘T/E’ Ratio

Does the amount of money a company pays in taxes, as a percent of revenues, foretell future market
performance?
Wherever I’ve traveled over the last few years everyone has responded significantly to one particular
stock; Enron. Just the mention of that one word brings sighs and smiles from an audience. The same
reaction occurred with the mention of WorldCom, Global Crossings, and Adelphia.
These stocks share many things in common. They were once perceived as great long term growth
issues, stocks to hold for the future. More importantly though, they all went bankrupt and seemingly
without warning.
A cursory look at their balance sheets showed off more growth momentum and earnings than Britney
Spears showed off her tummy. A closer look though showed they all shared another quality that sug-
gested the books were cooked.
Consider this, in 1999 with a market value of $104 billion, WorldCom represented 1.1% of the total
S&P 500. Between 1996 and 2000, WorldCom generated $16 billion in profits. That’s a staggering
amount of money... but it was largely bogus. Enron is the United States' second largest bankruptcy
in terms of lost value, about $66 billion. There had been rosier times; between 1996 and 2000 Enron
generated pre-tax profits of $1.8 billion.
Then there’s Global Crossing... a $30 billion bankruptcy... Adelphia... $21.5 billion bankruptcy...
These bankruptcies all share a common trait that differentiates them from other high profile insol-
vencies; they all reported splendid earnings right up until the point of implosion.
The earnings were fraudulent, of course, manipulated by corporate guys. But the point is this: these
bankruptcies took the market by surprise. Investors couldn’t possibly have known what was coming
at them... Or could they?
WorldCom only paid $298.5 million in taxes on that $16 billion, for an effective tax rate of 1.9%.
Enron claimed to make all that money, yet they got back $381 million from the government in tax
credits... which means they had a negative rate, -39.5%. The more they supposedly earned, the less
they paid!
“The only way to tell the genuine companies from the frauds
was to find the ones that actually paid taxes.”
- Victor Niederhoffer, Practical Speculation
The logic is simple - the more profits a corporation generates each year, the greater its tax liability
should be. If they can’t pay --- or aren’t paying --- the tax man, the earnings may well be bogus.
Stated another way, a high tax bill may be the true mark of success.
While earnings may look high, if the company’s tax bill doesn’t follow suit we have to worry about
the quality of the earnings and the accounting.
Here’s where it gets interesting... not only does this indicator protect you from dodgy earnings, but
it can also be used to increase your stock returns. For example, let’s take two companies. They both
earn $100 million before interest and tax. Company X pays $30 million in tax, while company Y
only pays $10 million in tax. All else being equal, which company would you rather own? Most in-
vestors would go for the company paying the lowest in taxes... but that’s not actually as good of a bet
as buying stocks in companies that pay taxes.
According to the study by Niederhoffer, the stock price of companies that pay less tax tend to per-
form WORSE than companies that pay more tax, given the same level of earnings. In other words
Vic’s work shows... a high tax rate is good for the stock price. It’s a counter-intuitive idea, as all the
best stock market indicators always are.
Comparing taxes paid with cash earnings, Niederhoffer split the 30 stocks of the Dow Jones Indus-
trial Average into two equal groups... those that paid the most tax compared to earnings in 2001, and
those that paid the least. He found nine months later that the high tax group returned, on average, -
13.9%, while the low tax group returned –22.3%. (The DJIA declined by 18%.)
Intrigued by his finding, he repeated the test on 50 randomly chosen S&P 500 stocks. The result was
the same. The 25 high taxpayers returned -15.7% while the 25 low taxpayers returned –31%, show-
ing once again, a high tax rate is good for the stock price.
Introducing The “T/E” Ratio

I also was intrigued by these numbers so I ran a test in which we bought the 5 highest paying com-
panies in the Dow or the 5 companies who paid the least in terms of taxes/earnings. Hence we have
Taxes to Earnings or T/E ratio to help us ferret out winners from losers. The Niederhoffer studies
cited above were conducted on a small sample of data. Therefore, I diligently applied the T/E ratio to
the Dow 30 stocks, buying the 5 with the lowest T/E in one test, the 5 with the highest T/E in another
test.
While the charts below demonstrate the anticipated results and clearly support Vic’s research, there
is more here than meets the eye. On balance the low tax paying companies show an average an-
nual gain of 10.04%, which I’ll round off to 10%. The 5 stocks with the highest paid up tax bill gain
13.99%, which I’ll round that up to 14%.
40% BETTER
The net difference is a decent amount... 4%... a 40% higher rate of return from companies that pay
taxes.
Chart 28: Buy Lowest T/E Ratio

Chart 29: Buy Highest T/E Ratio in Dow
Looking a little closer at the raw data though, I see the returns are also erratic. To drive home this
point, I’m showing the results from 1999 to 2005 so you can see that while, on average, the high T/E
companies do better; it’s no sure thing.
5 Lowest T/E Stocks

Year 3 Month Hold 6 Month Hold 9 Month Hold 12 Month Hold
4/1/1999 17.473% 6.127% 2.087% -1.528%
4/1/2000 -16.123% -6.183% 12.647% 6.021%
4/1/2001 8.142% -3.71% 15.67% 12.953%
4/1/2002 -12.235% -22.811% -15.089% -19.314%
4/1/2003 5.432% 12.671% 29.051% 23.375%
4/1/2004 -6.71% -3.301% 2.001% 2.237%
4/1/2005 4.132% 7.443% 12.05% 12.05%
Table 10: Buy 5 Lowest T/E 1999 - 2005
During this time period the lowest T/E stocks have done rather well, beating the high T/E stocks as
the next table shows.
5 Highest T/E Stocks

Year 3 Month Hold 6 Month Hold 9 Month Hold 12 Month Hold
4/1/1999 3.128% 1.236% 20.206% 30.49%
4/1/2000 -11.888% -9.002% -22.812% -30.299%
4/1/2001 13.358% -11.229% -3.742% -0.043%
4/1/2002 -15.977% -25.416% -18.689% -20.265%
4/1/2003 11.864% 19.082% 25.654% 19.032%
4/1/2004 -0.589% -0.388% 3.966% 3.531%
4/1/2005 -0.078% -1.856% 4.216% 4.216%
Table 11: Buy 5 Highest T/E 1999 - 2005
One should note these results are DRASTICALLY SKEWED by survivor bias... in other words,
influenced by the low paying tax companies like Enron, which went broke. Next we look at the com-
panies who paid the most in taxes relative to their earnings.
Chart 30: Buy Highest T/E Ratio in S&P 500
The results here are not as dramatic… but please keep in mind the survivorship bias.
So... do we have a great tool here or just what do we have? I’d rate this as one to look at, not put all
our chips on --- but --- in looking at stocks outside the Dow 30, I think it can be an invaluable tool
protecting us from the guys and gals that cook the books which then can cook our goose.
Speaking of Taxes…
Tax domicile or residency is another issue. The following data from Bloomberg paints a pretty pic-
ture for us. Companies domiciled in low tax states do better than the S&P 500.
The following table reflects the results from Bloomberg’s study of companies domiciled in low tax
states.
Bloomberg’s Companies Domiciled in Low Tax States

State Study Start Date Annualized Return
Arizona 12/31/1994 16%
North Carolina 1/2/2002 5%
South Carolina 12/31/2001 10%
Florida 12/31/1994 2%
Texas 12/31/1994 12%
S&P 500 12/31/1994 4%
Data for Nevada was not available
Table 12: Bloomberg Company Domicile Study
Where a company does business, can make a large impact on their bottom line. Most Dow 30 stocks
are headquartered in Delaware, so this does not apply as well to them. But, given two equal compa-
nies in the same industry, one filing in California and the other filing in Texas, the selection if obvi-
ous... avoid high tax states in your selection of companies.
Across the Pond... Same Story

The dullards of the EECU don’t get this message. So I’ll make it clearer. We can see the impact of
taxes in Europe quite easily by looking at stock returns there on the high and low tax countries for
the last five years. One study revealed that the stock averages of the high tax countries were up an
average of 52% while in the low tax countries the averages were up 86%.
Momentum Players Are Destined To Fail
I know those are pretty strong words in a stock market world where 80% of funds are trying to buy
hot stocks, and a great many funds’ basic approach is to buy breakouts and new highs.
Perhaps this works outside of the Dow 30. I don’t know since I have not tested it. However, my
sense is that there is little difference between the Dow and stocks in general. Momentum players can
find success, but for sure not in the Dow.
Over the years I have looked at several ways of technically selecting, not fundamentally, stocks to
buy at the right time; mid October of each year. We have looked at buying low priced stocks and
know they outperform high price stocks. I recently did reserach on buying the stocks with highest
and lowest relative strength ratings of the last 6 and 12 months, from which I learned that the rela-
tively strong stocks under performed the weak stocks. Indeed, the first now shall later be last.
I want to revisit my work in this area since there is another way to look at how strong or weak a
stock has been.
Moving Averages
It’s very easy to use moving averages as a tool. They are available in virtually every software sys-
tem, even the free stuff on the web. There are as many ways to use moving averages as there are
moving averages. A simple tool can be derived from just determining how far above or below the
price of a stock is relative to a moving average of its price. The math is very straightforward.
(LAST PRICE- MOVING AVERAGE)/MOVING AVERAGE)
If the last price is below the moving average you will have a negative %. If above it, you will have a
positive %. Using this formula I then take buys based on those stocks with the most positive readings
and those stocks with the most negative readings. We buy in October and exit after a 9 month hold.
However, which moving average should we use? Using the most widely applied moving averages I
conducted tests based on how far price is above, or below, the following moving averages:
Closing price +/- 20 day moving average
OK, what do you think? What will be the best strategy; buying the stocks furthest above their mov-
ing average or the ones furthest below? The next question is which moving average will be the best
to use... or is it meaningless? Finally, can we learn anything from this study that we can incorporate
in our investment strategy. I used stock prices from 1975 through 2006 for this study.
ANSWERING THE QUESTIONS… 20 DAY AVERAGE STUDY
The first moving average study looks at buying stocks the farthest above or below a 20 day moving
average. This is a short term view of prices. One might think that buying at the time when the stocks
that are short term oversold, or have shown short term strength, might be a good policy.
What we learn is that there is a 3.4% greater return, on average, over the last 30 years, when buying
stocks the farthest below the 20 day moving average as opposed to buying the ones above.
Chart 31: Buy Highest Stocks Above 20 Day Moving Average
Chart 32: Buy Lowest Stocks Relative to 20 Day Moving Average

200 Day Average Study
What do you think happens when we take an even longer term view of price? In this study, again us-
ing the Dow 30 stocks back to 1975, we buy the 5 stocks trading the most above the 200 day moving
average, as well as the 5 trading the farthest below the 200 day average. This 200 day moving aver-
age is the most widely followed stock market moving average of them all, and originated with the
work of Bill Jiller in the 1960’s.
Again there are two ways of looking at this... one is that you would not want to touch the stocks
below the average because they are severely depressed. Then again one might step forth with the
argument that you would not want to buy the ones the furthest above the moving average as they are
overbought. So you do nothing?
Momentum players have long used crossings above the 200 day average as a buy, or as a measure of
relative strength.. do we want to follow such a strategy?
Chart 33: Buy Highest Stocks Above 200 Day Moving Average
Chart 34: Buy Lowest Stocks Relative to 200 Day Moving Average
What I like about this data is the consistency, as you can see in Table 13.
Momentum Study Results

Moving Average Highest Lowest
20 Day 12.5% 15.9%
100 Day 12.9% 17.1%
200 Day 14.2% 18.6%
Table 13: Moving Average Study with 9 Month Hold
The longer the term of the moving average, the more profitable the strategy is for the investor, and
by quite a bit. A 6.1% advantage to the investor who buys the stocks under the 200 day moving aver-
age vs. the one who buys the 5 Dow stocks the most above a 20 day moving average. In all instance
the stocks furthest below the average in question performed the best.
You’ve Seen The Rest, Now It’s Time For The Best
So far, I’m certain you have learned more about what works the best in stock selection than you ever
thought possible. I have saved the best for last so you can see, appreciate, and compare the various
value measurements you have heard about.
A careful review of the proceeding studies makes it very clear that low price stocks, in a blue chip
average, offer the greatest bang for the buck.
With that in mind let’s turn our attention to what I think are the surest value ratios for these stocks:
PRICE SALES RATIO

12 MONTH FORWARD P/E
The price to sales ratio is similar to the price to earnings ratio, but compares the price of a stock vs.
the total annual sales of a company instead of earnings. High price to sales ratios are typically bear-
ish, low ones bullish. This is arrived at by taking the total capitalization of the company and dividing
this by annual sales. All we're looking at here is revenues to shares as opposed to earnings to shares.
There is an apparent problem here; the company may have large revenues but no profits. That's a
distinct possibility. O'Shaughnessy has described this ratio as the “King of the Value Factors.” In
one of his studies he took the 50 lowest price to sales ratio stocks, that’s the bullish ones, and com-
pared those to the 50 highest price to sales issues. He theoretically invested $10,000 in this group
of stocks in 1951, and would have turned it into 8.2 million dollars by 1996. That's a 16 percent per
year compounded rate of return.
Had an investor chosen to invest that same $10,000 in the fifty stocks with the highest price to sales
ratios in 1951 his $10,000 would have been worth $91,000 in 1996. What a huge and gargantuan
difference this price to sales ratio can make.
If you want to control of the risk of your investments then you'd definitely want to pay attention
to this price to sales ratio. I performed an interesting study of my own. In my study we looked at
buying the Dow Jones Industrial Average each year at the end of October our selection criteria as to
which stocks to purchase was broken down in four fashions.
In one test we bought the 5 Dow stocks with the highest price to sales ratio. In the next test we
bought the five stocks with the lowest price to sales ratio in the Dow. We then turned our attention
to the five stocks with the highest P. E. ratio and completed the analysis by looking at the five stocks
with the lowest P. E. ratios. The results are fascinating and are shown on the following page in Table
14.
Buy 5 Dow Stocks Based on Specific Ratio

Selection Technique Annual Return 1980/2000
Low Price To Sales 15.74%
High Price To Sales 10.74%
Low Price To Earnings 15.98%
High Price To Earnings 14.69%
Table 14: Value Ratio Study 1980 - 2000
Since that study I’ve done a lot more work on Price Sales ratios including looking at not only the
Dow 30 but also the S&P 500, which I like to do as it is a broader average. My most recent studies
are presented here and show again that there is a substantial difference in the performance of high
and low price to sales ratios.
Let’s start with a look at the results of buying the 50 highest priced to sales stocks in the S&P 500
with our late October entry and various time periods for exits.

50 Highest Price to Sales Ratio in S&P 500
14.75%
16
14
12
10
8.11%
7.22%
% Return 8
6
3.62%
0
Chart 35: Buy Highest Price to Sales Stocks
Not bad, the average 6 month hold was 7.22%, but we can do much better based on the next chart
that shows the results of the same entry and exit but on just the 50 lowest price to sale stocks.

50 Lowest Price to Sales Ratio in S&P 500
25
20.33%
20
15 12.50%
10.85%
% Return
10
6.36%
0
Chart 36: Buy Lowest Price to Sales Stocks
Our 6 month hold jumps up to 12.5%... a 73% higher rate of return. Another solid ratio is to be
found in either the current price to earnings ratio or the 12 month forward P/E ratio. This is a mea-
sure of the price-to-earnings ratio (P/E) using forecasted earnings for the P/E calculation. While the
earnings used are just an estimate and are not as reliable as current earnings data, there is still benefit
in estimated P/E analysis. The forecasted earnings used in the formula can either be for the next 12
months or for the next full-year fiscal period.
Also referred to as “estimated price to earnings.”
A Problem Presented Itself… And The Ultimate Answer

Once I had arrived at all this there was still a question that just had to be answered concerning what
we had learned, that low price stocks do really well and we want to buy them, generally speaking.
So, should we first screen for value stocks, say the 12 stocks in the Dow 30 with the best value ratios
and then buy the 5 with the lowest price… or… should we first screen for the 12 lowest priced stocks
and buy the 5 best value stocks of the low priced selection?
The answer is that it is best to first screen for value; then buy the 5 lowest priced stocks in that
group. Using that criteria produces the following results for our 6 and 9 month hold for the late Oc-
tober buy point:
Best of the Best

Value Ratio 6 Months 9 Months
Price To Book 13.4% 18.5%
Price To Earnings 17.9% 24.0%
12 Mth Forward P/E 17.6% 24.2%
Low Price Sales 17.8% 23.9%
Table 15: Best Value Ratio Study 1980 - 2000
As you see the best two measures of value are earnings and price to sales. Your selections should
start with this group and then from the 12 best value stocks; buy the 5 lowest price, or lowest cap
issues.
That’s how you beat the market, that’s how my Darlings of the Dow have beaten not only the mar-
ket but almost all the mutual funds. It’s real simple, I screen for the lowest 12 month forward P/E
stocks, of those I narrow the list down to the 10 lowest price to sales ratios then 5 buy the 5 lowest
priced stocks of that group.
Putting it All Together... the Rubber Meets the Road
I hope I have not inundated you with too much data, too many numbers, charts and such to dissuade
you from this idea of creating a simple investment approach. I did want to give you a thorough edu-
cation in value ratings, the concept of growth investing, momentum stocks and the like. By doing
that I think you are now well grounded in your understanding of the stock market as well as know-
ing what works best. We've laid the foundation so now it's time to turn our attention to exactly how
to take advantage of this knowledge. It is for that reason that in this section I'm going to bring it all
home, to show you the simple to arrive at stocks that outperform the Dow Jones 30.
As you have seen valuation measures do make a substantial difference in the performance of stocks.
You have also seen that low-priced stocks tend to outperform high price stocks on a consistent basis.
What we will next be doing is combining two valuation measures, then using the law of the square
root to arrive at what are usually the five best performing stocks in the Dow Jones Average.
Clearly my research indicates that the best measures of fundamental value, by and large, are the 12
month Forward P/E Ratio and the Price to Sales Ratio.
To find the value of these two ratios for each of the Dow 30 stocks, I use a stock screener.
My favorite is FINVIZ’s stock screen. It is very easy to create a unique stock screen of your own.
You can not only add the 12 month forward P/E ratio and price to sales ration, but you can add all
of the value ratios I have discussed if you so wish to do so. This is really a thing of beauty… all the
popular valuation measures are there.
Go to the following web site page to find FINVIZ’s Screener.
http://finviz.com/screener.ashx
It won’t take you long to create a screen by selecting the criteria I have taught you from the various
pull down menus and tabs. I’ve included some images of the screener so that you can see how it is
done.
Chart 37: Select Your Market Segment - DJIA, Then Fundamentals Tab
You can start out with the Descriptive tab (default setting) selected and pick DJIA from the Index
menu. The screener will automatically update with each selection.
Chart 38: Criteria Selected - Updates Automatically

Finally after the screener returns the stocks that meet the screening criteria, you can export the
results to software, such as Excel for further analysis.
Chart 39: Export for Ranking and Analysis
Not only is this stock screener easy to you. The data is reliable and it’s free!
So, now you have all the 12 month forward P/E ratios for each of the Dow 30 stocks as well as price
to sales ratios.
The problem is, how can we compare price to sales ratios? A very good one is usually say .90 to
1.90. With the 12 month forward P/E ratio, typically the numbers range from 12.0 to 25.
While both of these valuation measures are important I wanted to combine them into one central
number. Here is how I arrived at that; to give these measures equal value I simply moved the deci-
mal point over one place in the price to sales ratio. If the price to sales ratio was 1.25 my new way of
looking at this measurement would be to make it 12.5.
By doing this I have a number comparable to the 12 month Forward P/E Ratio which is most always
a two digit number with one decimal place.
The next step was to simply add the two numbers together, that is adding the new price to sales ratio
with the decimal point moved one digit to the right to equal the 12 month forward P/E ratio.
Let's look at another example… let’s say the price to sales ratio was 1.36 and the 12 month forward
earning ratio was 13.79. The next step is to convert the 1.36 reading to 13.6 then add the 13.79,
giving us a new reading of 27.39. By doing this I was able to establish one number for each stock
that seemed to be the best weighting of the two valuation measures. The lower the number, the more
bullish or better quality (value) the stock presents for us. We know that low 12 month Forward P/E
Ratios are bullish and we know low price to sales ratios are bullish. What I've done is add these two
numbers together into one number; then all we have to do is look for the lowest readings within the
Dow 30 stocks.
There is no magic number, no number that is better than another number, it is all relative. What we
are looking for is the lowest value stocks in the Dow. When the Dow is at substantial values we will
be seeing high price to sales ratios and high P/E ratios. But this little formula will still have us buy-
ing the best value stocks in the Dow, on a relative basis.
At one time that number may be, say 26.2, while at another time in the marketplace a good reading
might be 13.2. What's meant here is that there is no magic number to look for. What we are looking
for is the lowest or best value stocks in the Dow at that particular time.
As you saw earlier low-priced stocks tend to outpace high price stocks. We can take advantage of
this little known fact by adding another step.
I arrive at the 10 stocks in the Dow to have the lowest combined price sales and 12 month forward
P/E earnings number as described above. That is my first screen I then buy the five lowest price
stocks within that group.
By doing this we are first finding value in the Dow then turning our attention to the power of the law
of square root; buying stocks that have significant percentage moves larger than high priced stocks.
This is the ultimate combination for you to apply your own investing.
Larry Williams Simple Little Stock Investment System
After 50 years of studying the stock market, looking at charts and the balance sheets
until I am blue in the face, I decided it was time to put together a comprehensive,
and very simple, approach anyone can use to investing in the stock market.
The idea for this strategy was generated from the people who I come into contact with every day.
Whether it was fellow traders, my doctors, dentists, lawyers, or handyman they all have asked me to
help them with some approach to investing in the stock market.
Just like them, I also have questioned exactly what the best approach to handling my retirement
funds is. Should we be in mutual funds? Should we be just invested in short-term commodity trad-
ing? Perhaps real estate or gold, was the question and you have learned the answers. Here is the
ultimate solution.
While all of these investment opportunities offer the potential for profits and losses, they are all spe-
cialized and whatever approach you choose would not be as simple. When I talked with one of my
dentist friends about an investment program, he repeatedly pointed out that he doesn’t have as much
time to put into it that I, as a professional investor/trader does. He’s so busy making his money he
does not have time for investing his money. Turning it over to others has not done well, either.
“Keep it simple, please keep it simple”… that has been the admonition of every single person who
talked to me about writing this strategy.
So let’s do that. Let’s keep it very simple. The first step in bringing simplicity to the stock market is to
eliminate some 15,000 actively traded stocks by saying we will only invest in the 30 stocks in the Dow
Jones industrial average. We will never look outside of that universe. Then we will narrow that down
to just 5 stocks.
That means we’re going to miss some phenomenal growth stocks, it also means were going to miss
many stocks that will go broke. The essence of this program will always be in blue-chip stocks. This
guesswork, or leg work for stock selection, has already been taken care of for us by the folks at Dow
Jones. They routinely cull stocks in and out of this list with almost as much frequency as the rotations
going on with players by a head football or basketball coach.
Wow! We just got from 15,000 stocks to 30, see how simple this is!
There are two questions remaining. When do we buy the stocks and which of the 5 out of 30 stocks
should we buy?
I will first show you my approach to the selection of best stocks within the 30 stocks in the Dow Jones
industrial average and then give you a timing approach versus a non-market timing approach. Finally
you must decide which of these you would like to use. They both have their advantages.
Stock Selection
Not many of us have enough money to buy one thousand shares of all 30 stocks in the Dow Jones In-
dustrial Average and if we did that would be getting the same returns as the Dow itself. No advantage
there. Why not find the five or 10 best value stocks within that group and invest in just them? The
idea…and it is a very important idea…is to eliminate the laggard stocks in the Dow. Invest in the
rest of the 30, and by definition we outperform the stock market. That is something very few people
have ever been able to do with consistency.
I could regale you with my study of fundamental analysis of stock prices or show you the tremen-
dous amount of research I have done the last 25 years to determine which value measures are the
best when it comes to identifying winning stocks in the Dow Jones industrials. There is a litany of
ratios and values, many you have heard of, price-earnings ratios, price-to-book ratios, as well as
many you have never heard of.
Let’s look at just a few of the tests we have done, starting with what I thought was a stroke of bril-
liance. I compared the Current P/E ratio to the 12 month Forward P/E ratio. I was thinking if the 12
month forward P/E ratio was substantially lower, we could determine future value.
Chart 40 : Current P/E vs 12 Month Forrward P/E Spread
Chart 40 shows how wrong I was. The top blue line buys the 5 DJIA stocks with the largest spread
between forward and current P/E ratios. The green line buys the smallest spreads and neither do very
well. The high spread makes about 13% annually, the low spread 11.5% and the Dow came in at
10.9%.
Our next test shown in Chart 41 was also a bit of a shocker. Here we tested buying the 5 highest
and 5 lowest Price to Sales stocks. The 5 highest should underperform (blue line) and in fact they
did underperform. The 5 lowest Price to Sales should beat the Dow by a lot but in fact they slightly
underperformed the Dow!
The 5 highest P/E stocks (green line) as expected did substantially underperform the Dow. The 5
lowest P/E should out perform, the light green line, underperformed the Dow 30!
Chart 41 : Price to Sales & Price to Earnings Study
What about trying to combine value with relative strength? Again I thought I had a real novel and
effective strategy.
Chart 42 : 10 Lowest Positive Forward P/E
And, again I was wrong. First I selected the 10 stocks with the lowest positive Forward P/E. Then
tested buying the 5 with the greatest 3, 6 and 12 month relative strength, rolling every 3 months
into any new ones on the list. The best, green line above, was using a 3 month roll on those with the
greatest 6 month relative strength. Yes, the group beat the Dow, but only by a smidgen. There are lots
of blind alleys in this business.
I tested a myriad of values, Pitroski, EBIT, Sales per Employee but usually struck out. I kept coming
back to two values that mattered.
In all of my research two values have stood the test of time in selecting high-performance stocks:
Price to Sales and 12 Month Forward P/E ratios.
In both instances, the lower the better.
In my “Darlings of the Dow Strategy” we use a weighted combination of these two to select the
best fundamental value stocks in the Dow. But even that is more work than some people choose to
devote so I decided to take it one step further.
We will only use one of these ratios… The 12 month forward P/E ratios. We will not even care what
the number is, as long as there is one, it means the company is projected to be profitable next year
(our investment time frame).
So how do you go about finding out a 12 month forward P/E ratios of all 30 stocks in the Dow?
You could, of course, go to Yahoo or any search engine and find out the P/E ratio for each stock,
but that’s going to take you 30 screens or Google searches. Instead, why not use http://finviz.com/
screener.ashx? This is a free screening service. This service shows you more information than you’ll
ever be able to use about individual stocks. Using their stock screener (see screen shot below) I sim-
ply insert “DJIA” under filters when it asks for which index I want to monitor.
You can see the selection in the yellow highlight bar below. This means the stock screener will only
look at the 30 stocks in the Dow Jones Industrial Average. As mentioned, there are a variety of in-
dicators one can look for. I just do a search in the “Valuation”, which you can see here with the light
blue highlight in the lower left of the screen. In the following screen shot the 30 stocks are listed in
alphabetical order. The “Valuation” screen gives us the forward P/E for all the stocks in the Dow.
Chart 43 : Select Valuation
There are no more screen shots or such to do.
Our rule is to buy the 5 lowest price stocks....

with a positive 12 Month Forward P/E
All of the 5 lowest priced stocks, when this clip was taken, had positive numbers. So - if I was
buying at this time - I would buy these 5 issues.
While BAC does not have a Current P/E because

they had been losing money, the projection for profits next year
is for a Forward P/E of 5.68, so it qualifies.
(In all my studies I have limited my selection to 5 stocks but see no reason why you could not select
the ‘best’ 5-8 stocks our formula selects)
Our first screen is quite simple. We will click on “Price” to sort these stocks to have an order of the
lowest-priced stocks first. You can see how I did that in the second screen shot. We will be paying all
of our attention to low-priced stocks. Our first dance through the information is to find the lowest
price stocks because they substantially outperform other stocks within the group.
If you are looking for a real, real simple and easy way of selecting your five stocks, then you need to
know about the Law of Square Roots. If you are skipping ahead in the course back to that rule before
you proceed.
What you see below is a list of the Dow stocks, sorted by lowest price first. These are the ones we
will buy. Pretty Simple.
Chart 44: Screen Lowest Price First
We first rank the 30 stocks in the Dow ascending price order. We will then buy (when the time is
right) the 5 lowest priced ones after taking out any that do not have a positive 12 month forward
P/E. That’s all there is to it.
Timing Our Entries
Note Chart 42 that whatever roll period you chose, 3, 6 or 12 months, they all substantially out
perform the Dow itself… all rolls beat the market. The standard we judge performance by is the
Dow 30. In short, you can beat the market.
There are several ways you can play these stocks. If you want to maximize your return you will buy
the five lowest price stocks in the Dow that have a positive 12 month forward P/E ratio.
You will hold the stocks for three months. At the end of 3 months you will check to see if there is a
new group of 5 stocks. You will then roll into any new stocks but keep any of the current positions
that are still in the list. Toss out what no longer passes this screen. This is what I have to do.
This is the most profitable way to do it... roll at the end of every quarter. But as you see in the chart
this approach has the most volatility. When the market goes down you will too. The portfolio is not
immune to declines.
Your choice of roll period all depends on your temperament and how much time you want to put into
all this. If you want to avoid the more violent ups and downs of being fully invested at all times, you
need to look at the results from the simple seasonal timing model shown next.
Chart 45: Buy October 25 Results

For those that want to sleep at night and avoid most market slides we will use the timing model from
my 2002 book, “The Right Stock at The Right Time”; we will buy the 19th trading day of October
and exit May 15th.
We will be in the market about half the time in an attempt to sidestep major declines which usually
start in the May/June time period. While we will miss many massive sell offs, at times we will be on
the sidelines and miss a rally or two. But, not to worry, if you want high returns with low volatility
this is the way to go.
Making It Better Yet

I have developed a long term timing model for major bull and bear markets that is still a work of art.
The track record is excellent, but there’s way too much data for the average person to deal with and
maintain. In the past we have kept the signals for our annual forecast users only… in the future we
will make it available in some form.
Here are the dates of the sell signals, month ending, back to 1966 the buys are week ending;
November 1965 Buy 10/7/1966

December 1968 Buy 5/15/1970
October 1972 Buy 8/23/1974
September 1976 Buy 12/1/1977
December 1980 Buy 9/18/1981
July 1987 Buy 10/23/1987
June 1990 Buy 10/12/1990
August 2000 Buy 9/21/2001
October 2007 Buy 10/8/2008 and 2/27/2009
Using these buy and sell signals to move to cash and not sell short on sell signals propels the
annualize rate of return to close to 30%. Keep in mind that does not mean every year, it is an
average return for all years.
If you don’t want to keep all of the data that is required to make these long-term market calls, I
suppose we will offer to course students a major buy/sell service, so you don’t have to do the heavy
lifting.
As you will see in a moment the most successful way of using the strategy has averaged just a little
over 20% per year for the last 27 years. This is an astounding return far superior to the typical
buy-and-hold, whether it is the fund Warren Buffett has made his million dollar bet on or the Dow
Jones industrial average which returned 11.95% during that same time.
I’m certain you realize this makes a substantial difference in your long-term investing for retirement
programs and such.
If you invest $100,000, never add a penny, to it but receive that 11.95% return in the Dow for
20 years your $100,000 will be worth $956,000. Had you, instead, invested in the program I am
advocating here your $100,000 would be worth $3,833,000. The magic of compound interest is
amazing and of course the higher rate of return the quicker you are going to be in the chips.
In over 50 years on Wall Street I have never seen a program… anyplace… that can produce this
type of return with such ease and simplicity that anyone can follow. It will just take you a matter of
minutes at the end of each quarter to determine which stocks are the lowest price ones in the Dow
and have a positive forward P/E ratio. That’s it! The only other issue is market timing; I’ve taught
you a good deal about that here. Or of course, you could subscribe to our market timing service
which will also touch on stock selection.
Now here it is… Probably the most amazing long-term investment chart you will ever see. The
green line at the top of the chart shows the results of our five lowest close positive forward P/E
ratio stocks in the Dow with rolling into any new ones every three months and kicking out ones
that are no longer in that list. It outperforms the blue line which is to do the same roll but every six
months which outperforms rolling every 12 months, the orange line. All three of these strategies
substantially outperform the Dow Jones Industrial Average itself, the red line at the bottom of the
chart
Chart 46: Positive Forward P/E Various Rolls
That little green line of performance at the top of the chart has a 20.10% average annual rate of
return.
Some claim the EBITDA ratio (earnings before interest, taxes depreciation and Amortization) is the
best ratio to look at while others say the best ratio is Price to Sales. Here is what the data tells us.
Chart 47: EBITDA Comparison
Clearly the Forward P/E group blows EBITDA out of the water.
Chart 48: Quarterly Returns

Getting Technical
So fundamentals are not your thing? There is another approach you could take to all of this that does
not rely on fundamentals.
Check out this test of the five strongest stocks in the Dow 30, the ones that have the highest relative
strength for the last six months, rolling every three months into any new stocks in this group, and
kicking out ones that were no longer in the group. We also tested rolling every six months and every
12 months.
As you can see in Chart 49 the blue line shows the results of buying the five strongest relative
strength stocks in the Dow when rolling every six months. It does substantially outperform the Dow
as it does the other time periods using this rolling technique. However the performance still lags the
fundamental selection technique you just learned. The best of these relative strengths approaches
produces an average annualized rate of return of only 13.13%, a far cry from what we are able to do
with the fundamental selection technique.
Chart 49: Strongest 6 Month Relative Strength
Clearly this shows that relative strength works, without knowing anything about these companies,
their valuation, etc. If they have been strong, they outperform the market. But beating the market is
not enough we want to substantially outperform the market and it’s clear, fundamentals or the path
way to that future.
We do that ourselves. We may buy a little earlier. We may buy on a pullback. That’s just the art of
investing. The basic strategy is what you want to follow. There are nuances. But all too often, the
nuances get in the way of being fully invested in the market and capturing the upward drift that is so
positive with fundamentally strong stocks.
Next, I will teach my stock trading methods.
Disclaimer


Larry Williams
Stock Trading and
Investing Course
Part 3
A comprensive guide
the right stocks at
the right time.
Part 3
Stock Trading
Contents
Stock Trading 4
Secret One 4
Secret Two 6
Williams VIX FIX Index 9
Williams Paunch Index 13
Major Tops and Bottoms - End of the Trend 16
Valuation 18
Seasonally Speaking and Trading 22
Measuring Accumulation Distribution 27
Williams Sentiment Index 31
When to Get in - When to Get Out 34
Market Structure Explained 37
Time to Trade! 43
Mechanical Trading Strategy 49
How to Trade Holidays 50
Disclaimer 72

Stock Trading
Here’s my first secret of stock trading; the shorter your time frame, the more
certain you are to lose money. I have found that a trading time frame of 3 to
12 days presents traders with the easiest to reach low hanging fruit.
Here’s how to harvest those trades...
- Larry Williams
Williams.
Stock Trading
Speculators are lured by the potential of quick and easy money to short term trading. The dream most
often turns into a night mare as harvesting such profits are not from the lowest hanging fruit. Here’s
what Jesse Livermore had to say about such trading;
“I can’t tell you how it came to take me so many years to learn that instead of placing piking bets on
what the next few quotations were going to be, my game was to anticipate what was going to happen
in a big way.
‘Well, you know this is a bull market!’ was always the old codger’s reply. He really meant to tell
them that the big money was not in the individual fluctuations but in the main movements-that is,
not in reading the tape but in sizing up the entire market and its trend.”
If you are still in a rush to short term trade, consider these stats, “ In absence of any judgment of
time when purchases are made…buying a well diversified group of common stocks, our chances of
coming out even or making a profit are: Within 1 year, 78 in 100; two years 87 in 100; 4 years, 94 in
100”.
Of course you say those numbers come from the recent bull market; but you are wrong. They were
written in 1924 by Edgar Lawrence Smith, one of the all time market geniuses who clearly served as
the model for Warren Buffett.
If you want to catch short and intermediate term moves; here are my secrets.
Secret One
The creation of short-term profits comes from the most volatile stocks. Without volatility or rapid
price movement, it is very difficult for a speculator to make money. The other side of that coin, of
course, is you can lose money just as fast. But this is what you need; hot speculative stocks when
your time frame is anywhere from 3 to 30 trading sessions. Without these short term risks there are
no short-term rewards.
I can tell you what the most volatile stocks are (as this is written in 2015), Google, Apple, Face-
book, and Amazon. I cannot tell you what the stocks will be in 10 years from now. But, I can tell
you where to find them. Each day the New York Stock Exchange publishes a list of the most active
stocks, as you see in Chart 1.
Stock Trading | 5
Chart 1: NYSE Active Stocks List
A similar list is also published by the NASDAQ, which tends to have more volatile issues trading.
Chart 2: NASDAQ Active Stock List

What you will be looking for are stocks that are consistently in the most active list, making the list
for one or two days doesn’t count. You need stocks there almost day in and day out in the most ac-
tive group of trading issues. These are the ones that will be the most volatile. Also, since the volume
is high, it gives you the ability to get in and out easier than a market with less liquidity.
Secret Two
The secret is so basic but it’s the one that most all traders walk by. They glom onto actively traded
stocks or stocks they like to follow for some particular reason. Then they begin trading them, buying
and selling based on some technical tool, perhaps an oscillator or moving average.
Their cognitive bias, or belief, is because they are following the stock it will shortly have a substan-
tial move in the direction they are trading. This is where they missed the point… the secret to all this
is to have a condition that tells you this particular stock is about to rally or decline now. Stocks don’t
have major moves every week. You need patience and tools to tell you to stay out, not in.
Without having a condition to trade, the technical stuff will not work very well, if at all. It is all
about first establishing a condition that suggests the market will move in a certain direction, then
you can begin trading. Forget being a technical trader. You want to be a conditional trader. It’s really
simple; first find active stocks, then find conditions associated with when stocks had major moves in
the past.
With that in mind, let’s look at the conditions that are usually associated with significant gains in
stocks.
My favorite setup tools for conditional trades are:
1. Williams Money Flow Index

2. Williams VIX FIX Index
3. Williams Paunch Index
4. Williams WillVal Index
5. Williams True Seasonal
6. Williams Accumulation Index
7. Williams Sentiment Index
I believe it is the easiest to find significant setups for market moves using weekly charts. Once we
find a setup on a weekly chart we can then go to a daily charts to look at things like accumulation
distribution, trend and seasonality. But we begin with weekly charts for the setups, then go to daily
charts for entries and trend following.
Let’s begin with taking a look at my Williams Money Flow Index. I began developing this index in
1999. It simulates the buying and selling of large commercial interests in the commodity markets. In
commodity markets the government releases the Commitment of Trader Reports every week. From
studying that report we can see when these commercial interests become buyers and sellers and learn
how they approach the market. All I did, with that in mind, was develop an algorithm of how these
Stock Trading | 7
people buy and sell on a daily basis.

Once that algorithm was developed I carried it into the stock market. If the large commercial inter-
ests were to buy stocks they would most likely do it the same way they do futures.
The logic is quite simple. When these people have become buyers (especially to an extreme) most
likely the asset under discussion will rally. This tool is the red line in the following charts. When it is
high they have been buying and I expect rallies. It’s just the opposite for sells.
Chart 3: Apple Weekly Williams Money Flow Index
Apple has consistently been an active volatile stock. The problem with trying to trade it is if you buy
at the wrong time, like in 2012, you may see a severe decline in your account. That’s why I like the
idea of finding a condition that tells us this is most likely a better time to buy than some other time.
Take a look at Chart 3. I have marked off times that my index went into the buy zone. While not
perfect, there are some extremely impressive entry points based on just this tool.
Chart 4: Altria Weekly Williams Money Flow Index
This idea works on more than just the active stocks as you can see from the above chart of one of the
all-time great stocks, Altria. While this is more of an investment grade stock. It also presents some
wonderful intermediate-term buy points as evidenced by our indicator.
Chart 5: IBM Weekly Williams Money Flow Index
IBM has been one of the all-time great growth stocks though in recent years it has not fared well.
Nonetheless our index has been able to show us the most logical times to buy the stock.
Stock Trading | 9
Chart 6: Intel Weekly Williams Money Flow Index
Intel has been one of the most active stocks in recent trading years. Again you see the vertical blue
lines. Our indicator has done a very good job of telling us the best times to buy this particular stock.
Out of eight setup opportunities, only two of them were not good. Keep in mind that this is an imper-
fect business. But we can eliminate and sidestep some of the entries that don’t turn into opportunities
by increasing our understanding of these indicators.
Certainly, at first blush, this is a significant tool you want to use for setups. It will focus your atten-
tion on when to buy the stocks you’re following.
TAKE AWAY: Once you find a stock, the optimal buy zone will be when this index is above 74.
Williams VIX FIX Index

Here’s an index I developed while living in Australia because there was no volatility index for their
markets. I wanted to have a VIX Index not only for the Australian market but a tool that would emu-
late the index in the United States and have application to individual stocks.
Of all the tools I have done this is probably the least heralded despite very impressive track records.
A recent headline about it read, “Little-Known Indicator With a 65% Win Rate Signaling a ‘Buy’.”
A MarketSci blog report focused on developing a trading strategy based on just my VIX FIX index
and reported this;
Strategy rules: go long at today’s close when today’s WVF (that stands for Williams VIX FIX) read-
ing will close in the top 5% of all readings over the previous 30-trading days, otherwise move to
cash.
Numbers for the number-lovers:
Chart 7: Strategy Results Based on Williams VIX FIX
While the rate of return was the same for buy-and-hold, buy-and-hold had a 55% maximum
drawdown. Using my VIX FIX Index only had a 16% drawdown and was in the market only 13% of
the time to achieve the same gain as long-term buy-and-hold. Clearly this is an indicator we need to
pay attention to.
In 2015 Amber Hesta won the coveted Market Technicians Association annual “Charles H. Dow”
award for her paper based on this index. In her own actual trading she produced a string of 86
winning trades in a row based on this tool. Here’s what she said about it;
“…it all changed in 2007, when Williams published an article in Active Trader called “The VIX
FIX.” This article detailed an indicator that mirrored the VIX but could be calculated for any
stock, ETF, or security that’s traded. It was presented as a way to obtain the benefits of the VIX
for individual securities. I immediately realized that this idea was incredibly valuable and began
researching it in detail.
Williams’ new metric was a measure of volatility. When the indicator was high, volatility was high,
which is the ideal time to sell options. Unfortunately, this is also among the riskiest times to sell
options because we have no way of knowing when volatility has peaked.”
TWO WAYS TO USE THE INDEX
I have found two ways to use the index. The first is the easiest. By and large, whenever my volatility
index rises above 30 on a weekly chart, we are close to a significant market low.
Here are two charts of Apple. One goes all the way back to 1988 and the other is from 2006 to 2015.
In both instances you see when my VIX FIX index gets above 30 (red horizontal line) a market low
is close at hand.
Stock Trading | 11
Chart 8: Apple Weekly Williams VIX FIX Index
Chart 9: Apple Weekly Williams VIX FIX Index

Our general rule then is that any time we see this index above 30 we should be looking for confirma-
tion of buy signals in the stock we are following. Another insight is that often people buy too early
in a pullback. Thus it is wise to wait for the index to rise above 30 before you begin looking for an
entry point. Later on we will look at this on daily charts as well. But it’s a very good rule to confirm
our setups on longer-term weekly charts.
The second way we can use this index is to monitor the trend of volatility. When the index rises
above 30 and then turns down; it is a strong indication that the volatility, which has been on the sell
side, is abating and we are very close to a short-term market rally. Amber Hest pioneered this use of
my index on daily charts, not weekly, and I suggest you do read her MTA 2015 paper.
In the following chart of Altria I’m showing how you can draw simple trend lines on the VIX FIX
index for potential entries into the marketplace. There is nothing complicated about this. We are just
using the index on a daily chart. You could use a moving average but I prefer trend lines. You see
there are some very nice market tops and bottoms suggested by this indicator, which I’ve marked off
with red and blue arrows.
Chart 10: Altria Daily Williams VIX FIX Index Trend Lines
Here’s a chart showing the same technique on Amazon.

Stock Trading | 13
Chart 11: Amazon Daily Williams VIX FIX Index Trend Lines
As they say, in the land of the blind the one eyed man is king. In the stock market there is a great
deal of blindness as to when substantial moves should take place. Most people are just chasing their
tail. Now, you can see by using our indicators, that we can narrow down times to focus our interest
in the stocks we are following.
TAKE AWAY: stocks always (that’s a strong word) bottom with high VIX FIX readings. So this is a
tool to spot buying areas. Additionally sells are given when down trends are broken
Williams Paunch Index

The next indicator is another one of my very favorites. It’s based on the Welles Wilder ADX
indicator. Almost 30 years ago I made a unique discovery about this index. Others were focusing on
the trend of the index. But I noticed that when it was rising above 40 while stocks were declining,
substantial market lows were often at hand.
This has been a phenomenal tool that has held up exceptionally well for many, many years. I have
used to trade in Russia, South Africa, Italy, Germany, Beirut, the UK, France, Brazil, Argentina,
Canada, Japan, China, Hong Kong, Singapore, Malaysia…well you get the message. I may not take
my AMX card with me, but I never leave home without my ADX. We call it our Williams Paunch
buy.
The rule is elegantly simple. When prices have been declining and ADX rises above 40 we need to
look for buy signals. This is my conditional setup for rally. First we will look at it on weekly charts
than on dailies.
As long as we are looking at Amazon let’s continue to see how might my Williams Paunch Index has
done on this particular security.
Chart 12: Amazon Weekly Williams Paunches
The problem with this gauge is that it does not often signal. When it does it is powerful, but it does
not take place at every market low. In Amazon there were no buy setups from 2012 to 2015 on
weekly charts. The daily chart did produce buy setups as shown next.
Chart 13: Amazon Daily Williams Paunches

Stock Trading | 15
Here is a weekly chart of Costco followed by a daily chart.
Chart 14: Costco Weekly Williams Paunches
Chart 15: Costco Daily Williams Paunches

Major Tops and Bottoms - End of the Trend

There is another very valuable insight I have garnered from studying this index for so many years. It
also is quite simple. Whenever ADX gets above 60 that’s most likely the end of whatever the trend
has been. If we been rallying that’s the end of a significant uptrend. If declining, that is the end of a
significant downtrend.
Chart 16 of Starbucks shows when the index got above 60. It suggested the uptrends were over.
Chart 16: Starbucks Weekly End of the Trend
And here’s a chart you will want to follow-up on, Walmart in June 2015 was evidencing a bottom
based on our index rising above 60. Go back, check your charts to see if a buy point wasn’t
established.
Stock Trading | 17
Chart 17: Walmart Weekly End of the Trend
Recent (summer of 2015) tops in Apple were heralded with this gauge as well.
Chart 18: Apple Weekly End of the Trend

TAKE AWAY: The Williams Paunch Index sets up buys when > 40 while prices have been declining.
It sets up buys and sells when > 60 as an “end of the trend” trading indicator.
Valuation
This is the most unique indicator I’ve developed because it began in the commodity markets
and went to the stock market! The idea was that I had a sense of valuation for stocks, price-to-
earnings ratios, price to sales ratios, but we didn’t have anything at all like that for futures.
My notion was that agricultural prices have a strong relationship with the price of gold. So we could
compare - on a relative basis - the price of gold versus to wheat (as an example) and know if it was
undervalued or overvalued versus the price of gold.
Realizing that stock prices are heavily influenced by interest rates my next step was to compare the
price of an individual stock versus the price of bonds to develop a valuation index for any individual
stock. This is an intermediate-term tool using a 13 week look back to determine levels of under or
over valuation. It is certainly not for timing - with one exception - which I will get to in a moment.
Please note this is not a timing tool this is a setup tool.
For now, just keep in mind that when the index is high, generally speaking, an individual stock
is overvalued and should pull back. By the same token, when the index is low, again generally
speaking, we should be looking for rallies in the marketplace. Here are a few examples for your
study.
Chart 19: Altria Weekly Williams WillVal

Stock Trading | 19
Chart 20: Microsoft Weekly Williams WillVal
Chart 21: Alcoa Weekly Williams WillVal
The exception to this rule is when the market is in a strong uptrend and goes immediately
undervalued. This is an anomaly. Prices are never oversold in an uptrend. But, you will see instances
when we they are undervalued amidst a massive uptrend. These are unique and very bullish setups.
The opposite is equally true; when we are in a downtrend and go overvalued (telling us that relative
to the bond market the individual stock is high-priced) we pick up some substantial and immediate
sell signals to the downside.
These are unusual looking signals. Look at the following chart of Fastenal. In late 2005 and early
2006 price was in a strong uptrend but the valuation index went into the undervalued zone despite
the fact that FAST was very high price levels. That’s what you’re looking for. That’s what is so
bullish.
Chart 22: Fatenal Weekly Williams WillVa
Let’s next look at what a sell setup would look like using this index. Keep in mind we want to see a
market that is in a strong downtrend and goes into the overvalued zone.
Chart 23 of General Electric in 2002 shows the pattern we are looking for; a strong downtrend where
prices have not been building a base, then an immediate overvalued index reading.
Stock Trading | 21
Chart 23: General Electric Weekly Williams WillVal
Here’s another good example from Walmart in 2015. Notice price barely budged up in the middle of
May, but relative to bonds Walmart was overvalued and down it came!
Chart 24: Walmart Weekly Williams WillVal

TAKE AWAY: Stocks relate to bonds, thus we can look at the relative spread between them to detect
times of over valuation. This is a general index, except when price is a strong up trend and we get
undervalued readings, it is very bullish. The opposite is equally true; sell overvalued readings in
down trends.
Seasonally Speaking and Trading

Supposedly there is a time to sow and a time to reap which should translate into a seasonal pattern
for commodity prices. That was the idea I had in 1973 I wrote the first book, literally in the history of
the world, showing seasonal influences on all commodity prices. That book began an entire cottage
industry of people trying to use seasonal tendencies and patterns to make money trading. Most of
them failed. Admittedly I myself had problems using the seasonal influences.
While clearly there are seasonal influences, if we rely on the same ones to take place each and every
year… we’re going to get into trouble. Seasonals don’t work that way.
Just because wheat rallies in July does not mean it will rally this year in July. Crop conditions may
be different. There may be substitution of another grain. There may be war. There may be peace.
There may be a variety of reasons why this year the seasonal pattern will not work.
So what are we to do?
I was flummoxed for many, many years until about 2013. I had an idea that has proven to be one of
the best trading ideas of my life. While we know seasonals do influence prices my take away is that
they only influence price if this year price is congruent or stronger than the seasonal pattern. If so
then we will get a seasonal rally.
The flip side of this coin is if prices are making the same pattern as the typical seasonal down pattern
or weaker than the seasonal pattern, then if there is a down move scheduled for this time of the year
it most likely will take place.
Before we look at some charts let me restate what you want to do. Determine when in the past there
have been significant and sustained seasonal rallies or declines in the market. Then as we get to that
time zone this year look to see if price is matching the seasonal pattern, or even better if it is stronger
than the seasonal pattern, then most likely this year the seasonal pattern will work.
With that understanding let’s look at some seasonal influences that didn’t work and you’ll understand
why to further your education as a speculator.
Stock Trading | 23
Chart 25: Walmart Daily Williams True Seasonal Pattern
You are looking at a weekly chart showing the seasonal tendency for Walmart. As you can see prices
usually decline at the first of the year. They make a low in March, a peak in mid April, a rally around
the end of May, another rally at the end of July, a selloff late in July, and the best buy point of the
year in October.
The problem of course is there is no assurance that this pattern will take place in the following year.
That’s when we need to check and see what price is doing as we get to these seasonal rally points.
Knowing what you now know, we would been looking for a buy signal in March 2015 and a sell
signal around April. Let’s see how that played out based on what I’ve taught you so far.
Chart 26: Walmart Daily Williams True Seasonal
We would have been looking for that late February early March buy signal in 2015. Prices usually
rally then. As we got there we noticed however that during February Walmart sold off and continued
selling off into March when they should’ve been rallying. That warned us that this year the seasonal
pattern probably would not work.
Price should’ve been making a new high in April, higher than in February, yet prices were making a
new low, telling us that this year and 2015, the seasonal factors would depress the price of Walmart.
You might just as well pour yourself a cup of coffee as we will now look at Starbucks. Like Walmart,
it also has a seasonal pattern to rally at the end of February as well as the end of May. Would these
patterns work in 2015?
The next chart should answer that question for you:

Stock Trading | 25
Chart 27: Starbucks Daily Williams True Seasonal
Next let’s take a look at the energy giant Exxon to see how we can use this technique to take as well
as to not take trades.
Chart 28: Exxon Daily Williams True Seasonal

As you can see from Chart 28 there is usually a rally in March. However, in 2015 while the seasonal
pattern indicates a higher low in March than November, Exxon was making a lower low. This told us
to bypass this supposed seasonal trading opportunity this year.
You can also see there is usually a decline in May. The question is, would want to take it in 2015?
The answer came from looking at price versus the seasonal pattern. Price was substantially weaker
than the seasonal pattern, indicating a well setup seasonal trade and that we should work this market
on the short side at this time.
I strongly suggest you look through your own charting services to see this relationship between price
action and seasonals. I leave you with this last one, QUALCOMM.
Chart 29: Qualcomm Williams True Seasonal
I’m certain most of the seasonal influenced advisory services would’ve been taking buy signals
in QUALCOMM in July and October 2014 because typically that’s when the stock rallies. But,
knowing what you know (seeing that price was substantially weaker than the seasonal pattern) you
would have known to bypass this trade.
You also bypassed the sell in April 2014. Traditional seasonal guys would’ve sold short and then saw
prices break to new highs in July. We would’ve passed the trade because we see prices making new
highs, being stronger than the seasonal pattern.
Stock Trading | 27
There was a selling opportunity in April 2015 when price was substantially weaker than the seasonal
pattern. In that case we would have been looking for and taking sell signals in this market.
TAKE AWAY: Stocks have seasonal patterns. They just don’t always follow them. They do follow
and exceed the seasonal patterns when this year’s price is stronger/weaker than what’s usually
taken place. This is an excellent tool for focus and trade selection, as we can see it all happening
far in advance.
Measuring Accumulation Distribution
I next want to share with you is an attempt to measure the buying and selling pressure going on each
day in an individual stock. I’ve been doing the best I can to detect accumulation in the marketplace
since my career began back in 1962. I believe we should be able to detect professional accumulation
coming into a market; if that’s true we could develop an indicator that would give us trade
confirmation.
I would not use this technique to establish a trade… once we see a trade is setup by any of the
our tools I would love to see confirmation that insiders are accumulating this stock at that time, or
distributing it if we’re looking for short selling opportunity.
Many people use the divergence between accumulation and price as a selection tool for the trade. I
am not very impressed with using it in that fashion.
There are many ways of measuring accumulation in the market. The typical one is referred to as On
Balance Volume, popularized by my late friend Joe Granville but originated by a husband-and-wife
team, the Vignolia and Woods in San Francisco the late 1940s.
The idea is that if price is making a new low as selling pressures come into the market, but our
accumulation index cannot make a new low, then the market is under accumulation and we should
expect a rally.
The sell setup is just the opposite. When price rallies to a new high there should be an equal increase
in accumulation in the marketplace. If there isn’t, our accumulation index does not make a new high
while price does, we have confirmation of a decline in the offing.
The problem with On Balance Volume is that it assumes all of today’s volume is on the buy side
even if the stock is up marginally for the day. Worse yet what if the market opens above yesterday’s
high sells off from that point, which is the high of the day, and closes up just a fraction for the day
and right on the low? Clearly most of the volume on that particular day would be sell volume but it’s
not treated that way by On Balance Volume , it’s treated as buying because of the net change.
The other problem with On Balance Volume as well as tools that measure accumulation I developed
in the 1960s is when they speak they are very good but they don’t signal often enough.
To get around this I developed something I call Williams Accumulation Index over at quarter of a
century ago. This is my measure of when professionals are accumulating and selling an individual
stock. Again it is not a setup tool. We are going to use it as confirmation.
Let’s begin looking at just the indicator by itself so you can see that divergences between price and
on this index are significant.
Chart 30: Johnson & Johnson Daily Williams Accumulation Index
The above chart of Johnson & Johnson shows the pattern you will be looking for. When prices
make a new low that is not confirmed by a new low in accumulation (that’s the green line) price
most often rallies. The selloff in June 2015 was clearly forecast when price made a new high yet the
accumulation index was not able to make a comparable new high. Thus there was distribution not
accumulation on that breakout rally.
Let’s look at some more examples.

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Chart 31: Disney Daily Williams Accumulatoin Index
Disney was a good example of this technique at work in 2014 and 2015. All you’re looking for are
divergences. This is not too complicated. When price makes a new high (as Disney did in September
2014) without a comparable new high in accumulation, we should be looking for selloffs. Buys
will look like Disney did in April 2014. While it was making lower lows in April than March, my
accumulation line was diverging, suggesting there was a rally in our future.
Chart 32: Facebook Daily Williams Accumulation Index

No stock seems to be immune from this technique. Facebook (Chart 32) presented traders with
numerous divergent buy and sell signals.
Look at one more chart, and please keep in mind this is a tool to confirm a trade, I don’t rely solely
on this one indicator. At times it will give false signals; not often which is why I really like to make
certain that I have a combination of ingredients working for me.
Chart 33: Twitter Daily Williams Accumulation Index
Even a newly issued stock, such as Twitter shows the ability this tool has to help us spot significant
buy and sell points in our stocks. You may well be asking, “Why does this work?”
The answer I believe is because I am measuring the accumulation/distribution of a stock on a daily

basis. We are simply looking at the supply demand that takes place each day. It is not unusual for
a stock to look apparently strong then fall out of bed. Why does that happen? Most likely, I think,
because the breakout has been false. There has not been real professional accumulation in that
market. What this indicator attempts to do is show when there has been false price moves not backed
by real accumulation in the market.
If the market makes a lower low while accumulation does not, it is telling me the market is in
strong hands. Somebody was there to support the decline, so while price looks weak the internal
accumulation of the market was positive.
TAKE AWAY: We can measure buying and selling pressures in the market and look for divergent
action; accumulation stronger than price for buys and weaker than price for sells.
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Williams Sentiment Index
One of the first wake-up calls for investors is realizing that most of the time the market predictions
from their brokers don’t work out. This is nothing new. It has always been that way. But, I decided
in the late 1990’s to take advantage of this by constructing an index that would allow us to see when
the advisors, broker’s web sites and other public prognosticators are exceedingly bullish or bearish
on stocks and futures.
My idea was not new. Jim Sibbett had, years ago in his advisory service Market Vane, a newsletter
for commodity traders. Jim subscribed to as many newsletters as he could, then tallied up the
percentage of them that were bullish or bearish. All I did was take this idea one step further,
trying to get a sense of when advisors are excessively bullish or bearish on individual stocks. For
more information you may want to refer to my book published by Bloomberg, “New Thinking in
Technical Analysis: Trading Models from the Masters” where this index was introduced to the public
in November 2000. We have well over 15 years of experience with this index, and the experience has
been good.
Again the rules are very simple. When the majority of advisors are excessively bullish, we would
expect a market decline. When bearish, we would expect the market to rally.
We will begin by taking a look at Twitter. The stock recently went public, yet it was not immune
to the idea that when everyone is bullish, the market most likely will decline. When bearish, it will
rally.
Chart 34: Twitter Weekly Williams Sentiment Index

Chart 35: IBM Weekly Williams Sentiment Index

The index works on large cap stocks, such as IBM shown next.
It also works on the hot actively traded stocks such as Google, Apple, and Amazon.
Chart 36: Google Weekly Williams Sentiment Index

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Chart 37: Apple Weekly Williams Sentiment Index
Chart 38: Amazon Weekly Williams Sentiment Index

Like most of our tools, this is applied to weekly charts and the purpose is not to tell us to rush out
and buy the stock. It is a setup - a condition. It is telling us that we now need to focus our attention
on the daily charts to look for entries, trailing stops, targets... all those things which I will next touch
upon next.
TAKE AWAY: The crowd can be right, but not for long. At extremes they are almost always on the
wrong side of things. When Williams Sentiment Index is excessively bullish, take sell signals and
when excessively bearish, it is your time to buy.
What you have learned so far are my setup tools for individual stocks. You can make a screen of
these or use the ones you prefer. Do you have to have all of them “there” to setup a perfect trade?
No, in fact that will seldom be true. However in my own trading I like to have at least three of these
setup tools suggesting to me that I have very good odds of entering a successful trade. Just like a
party, the more the merrier. But don’t expect all seven of these tools will be in their respective zones
for every trade. If you see that three of them are there, that’s good enough.
When to Get in - When to Get Out
Timing the Trade

We have come a long way. You have learned how to identify markets that are setup. That’s well and
good, but you still have to pull the trigger. You still have to get into and out of your positions. Most
people start at this point. As I mentioned earlier, that’s the problem. They think it’s all about getting
a buy or sell signal. That’s the last thing I care about. I first care about having the market setup for an
entry.
With that in mind, we will now look at some markets that were setup and then look at various entry
techniques.
There are two concepts when it comes to entry techniques. One is to buy when there’s a trend
change. The other is to buy when prices are falling out of bed, hoping there will soon be a trend
change.
The following chart of IBM shows my WillTrend index, a simple trend measurement technique
developed many years ago. Generally speaking when price closes below the red line, we are in a
downtrend and stay in that trend until price closes above the red line. When stock prices are choppy
during trading ranges, prices will close on both sides of this band. Whenever there’s a trend move,
the majority of the trend will be captured by my trend following tool.
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Chart 39: IBM Daily Williams WillTrend
While many chartists will just take buy and sell signals based on this, they are trading in the
dark. They do not understand our concept of setup trades. If we have a conditional entry in the
marketplace, most likely any trend change indicator will produce more than just a short-term bobble
in the market. It should produce a more substantive change in price. Once we have a conditional
setup, we then go to the daily chart and use this, or other similar indicators such as Wilder’s
Volatility stop, for our entry and trailing stop.
Here is a chart of Apple so you can get the sense of how this tool works.
Chart 40: Apple Daily Williams WillTrend
The simplest of all such trend change opportunities can be determined what we call trend lines.
These are easy to construct. If you are looking for a buy signal, you need to find the two most recent
short-term market highs, with the last high being lower than the prior high. Then connect the line
from these highs which will be slanting down in price. Getting to or closing above that price would
be your trend change in the market.
A selling opportunity would be just the opposite. You will be looking for an ascending, or higher,
short-term market lows. Then you can draw your trend line connecting these lows. Getting below
that line is your sell signal.
Of course we want this on top of a conditional or setup market.
The following chart of Apple shows several trend lines as well as one projected into the future. Since
Apple has been coming down we would look for a buy signal, assuming there is a conditional setup.
The trend line would be our entry point.
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Chart 41: Apple Daily Williams Trend Lines
Market Structure Explained
All markets move in cycles, swings, sprints if you will, from one point to another. I will teach you
how we can identify virtually all of the swing points. Once that has been done, we will identify
when these swing points setup buy and sell signals. So, let’s start at the beginning... with the initial
understanding of market swings.
We can pinpoint virtually all short-term market highs and lows with two very simple rule.
A market has made a short-term low when we have a day (or bar if you are using different time
periods) that has a higher low on both sides.
By the same token a short-term high will be a day (or bar) that has a lower high on both sides of
it.
Sounds simple doesn’t it? There is a wealth of information and market understanding in these swing
points. I want to make certain you understand this concept before we proceed further. I’m going to
show you, in our first chart, examples of swing points marked off, so you understand how they can
be identified on a chart.
I am using charts here of Pfizer (PFE). It does not matter what country, what time frame or what the
market is... market structure is always at work.
This is where it all begins. It is critical you understand that prices run in swings or streaks. We can
say a “run” to the upside is over when price fails to move higher the next day AND falls below the
prior day’s low.
Price action alone will unfold, revealing the swings of price movement. I have illustrated that on the
following chart of Pfizer.
Chart 42: Pfizer Short-Term Swing Points
Once we have that understanding we can then start to lay in the blocks of Market Structure, by
simply connecting these swings as the next chart shows.
It’s critical to identify the formation of these short-term highs and lows. We need to know precisely
when the short-term high or low becomes locked into place.
In the case of a short-term high, we know that a day is a SHORT-TERM HIGH the instant the low of
that day has been violated by price falling below that low. It is not just the fact that we have a lower
high, but that also that the low of the high day has been penetrated.
In the case of a SHORT-TERM LOW, we know that a day is a short-term low the instant the high of
that day has been violated by price to the upside. It is not just the fact that we have a higher low, but
that also the high of the low day has been penetrated.
The following chart should explain it better.

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Chart 43: Pfizer Short-Term Highs & Lows Formation
We can wrap all of this up by putting it this way; when a market has been in a downtrend and a day
exceeds the lowest day’s high, then the short-term downtrend has ended. The end of a short-term
uptrend will be known when the low of the highest point seen in the rally is violated to the downside.
You have learned how to correctly spot all short-term swings in the marketplace but is there more
here than what you are seeing? Yes, indeed there is. If we know that a short-term high is a day with
lower highs on both sides… then we can also state this:
• A short-term high, with lower short-term highs on both sides of it

is an intermediate-term high.
• A short-term low with higher short-term lows on both sides of it is an

intermediate-term low.
Now with those simple definitions, let’s look at the same chart where I have now marked off the
intermediate-term points.
Chart 44: PFE Intermediate-Term Swing Points
What we have been able to do is quite amazing. Without using a calculator, computer, or a
mathematical formula, we have been able to define short and intermediate-term trends of the market.
As I understand this, market structure allows us literally to determine the real trend of any market.
Chart 45: Pfizer Intermediate-Term Swing Points

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The yellow dots on Chart 45 show the intermediate-term swing points. Of course we don’t know
them until we have a higher short-term low on the right side of the low or a lower short-term high on
the right side of a high.
Notice the bar marked “known here” in Chart 45. We took out that bar’s low. That means on the
day the low of “known here” was violated, we knew we had a lower short-term high. Thus the
intermediate-term high was established at that precise point.
Even more interesting is that once we violated the low, we also determined that this intermediate-
term high is lower than the last intermediate-term high. So we are in an intermediate-term down
move. The longer-term trend is down, not up. Thus short sales could be considered.
You are probably already thinking, “Can these be nested together… if a an intermediate-term low
has higher intermediate-term lows on both sides of it, would a long-term low be known once we
have higher intermediate-term lows on both sides of it?”
Yes and the opposite would be true for intermediate-term highs.
• An intermediate-term high with lower intermediate-term highs on both

sides of it is naturally a long-term high by our definition; thanks to our
understanding market structure.
• An intermediate-term low with higher intermediate-term lows on both sides of

it is naturally a long-term low by our definition; thanks to our understanding
market structure.
Look at what we have done… we have been able to identify all the short-term swings in the market
which gives further rise to enabling us to determine the intermediate-term swings. Then they are
used to identify long-term swing points!
There are so many things you can do with these individual points, but I would like to make this as
simple as possible by driving home the basics of the concept.
The most profitable trades, and certainly the easiest ones to locate, are going to be based on the
intermediate-term trend of the market. These offer more profitable opportunities. However they
don’t occur every day. This is frustrating to people who want to trade 10 times a day or 10 times a
week. It’s been my experience that is not how you make serious money in this business. The money
comes from loading the dice in your favor and seldom rolling them. The more times you trade, the
more opportunities you have to stuff up your speculative activities.
Next, let’s look at what the ideal short sell pattern would look like. What you will be looking for is
an intermediate-term high that is lower than the prior intermediate-term high. This pattern clearly
tells us the trend of the market is down. The formation of the lower intermediate-term high should
carry the momentum of the longer-term time frame painted out for us by market structure.
The conceptual pattern for the best buying opportunity occurs when we are forming an intermediate-
term low higher than the last intermediate-term low. This tells us that the intermediate-term trend
is up. It is a question of swings… which is the larger current swing in the market? Find it and you
know the current trend of that time period.
With just these two patterns you have the optimal approach to trading, as you are indeed trading with
the power of the intermediate-term trend.
For a buy signal, we are looking for the formation of higher short-term lows to enter into a
conditional, qualified or setup a trade. This can be one of your entry techniques. If you’re looking
to sell short of course the formation of a lower short-term high that completes a lower intermediate-
term high would be the optimal use of market structure.
The next question is how do we get out? Can we develop a target for this trade, and what should our
trailing stop be?
Target Time
Let’s first talk about targets... markets don’t always go to targets, which is why it is critical you also
learn to have a trailing stop.
Price targets can be determined in several ways. Many people think Fibonacci ratios and such have
value and work for targets. I don’t. I have done several thorough research projects on these and could
not demonstrate that they work. Nor have I seen any other real research to back up any significant
Fibonacci levels. But to each, his own, as they say. This is just one man’s opinion.
What I have found is that markets do have a strong tendency to rally above the last intermediate-
term high by the same amount it moved from the intermediate-term high to the lowest point prior to
advancing to new highs.
In other words, if we have an intermediate-term high you take the distance from the high to the
intermediate-term low, and then add that value to the intermediate-term high. That gives us our target
or upside potential.
You can take any swing point low that has been violated and calculate the distance from that swing
point low to the last swing point high and subtract that value from the low for a downside target.
For an upside target simply take the distance from the most recent swing point low prior to the swing
point high, add that to the swing point high, and you have your upside target.
Here is an example for your study.

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Chart 46: Pfizer Targets Using Swing Points
You can use WillTrend as your trailing stop or simply use the lowest low of the last three or four
days. Those are good ways to bold the position for a long time when a trend move begins.
Time to Trade!
Let’s take what we have learned and find a trade
One of the best long-term stocks for investing as well as trading has been Johnson & Johnson.
Looking at the following chart on a weekly basis, in November 2009 you would’ve noticed that
while price had been in a large trading range suddenly our money flow index popped into the buy
area alerting us to potential trading opportunity.
Chart 47: Johnson & Johnson Weekly Williams Money Flow Index
With that alert we next look to see if there is any seasonal confirmation that price typically rallies at
this time of the year.
Chart 48: Johnson & Johnson Daily Williams Money Flow Index and True Sesaonal
What we see is that usually there is at least a bit of a short-term rally and more importantly this may
be taking place at the end of a long base of accumulation of price in an uptrend. With that in mind
let’s see if we can find accumulation in this market.
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Chart 49: Johnson & Johnson Daily Williams Accumulation Index
Now we have a very pretty picture…price has broken out sharply to the downside while our money
flow index has entered the buy zone. Accumulation has not broken to a new low, indicating the stock
is in strong hands at a time we usually see rallies.
All that is left to do is find an entry point which would’ve been pretty easy… you can see in the chart
below how this trade worked out.
Chart 50: Johnson & Johnson Daily Entry

Mechanical Trading Strategy

In just a moment I will show you the strategy but first I’d like to get your attention with the results.
To do that let’s look at the equity curves of this strategy applied to a few stocks.
AXP
Chart 56: AXP Strategy Performance Results
Chart 57: AXP Equity Curve

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KO
Chart 58: KO Strategy Performance Results
Chart 59: KO Equity Curve

MSFT
Chart 60: MSFT Strategy Performance Results
Chart 61: MSFT Equity Curve

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In a test of all DJIA 30 stocks for the last 20 years, it made money in all of them but two stocks, CAT
and PG. The other 28 stocks were nothing short of amazing with accuracy as high as 89% (UNH).
9 of the 30 had 80% or higher accuracy. This is amazing for a 100% mechanical intermediate-term
trading strategy.
Such great results mean you can use it on the stocks of your choice as well. I like GIS, COST, MO
and SBUX; it’s profitable in all these as well.
The strategy is easy to follow and you can vary it to suit yourself or the stock you are trading.
Here are the rules:
1) 8 bar ADX is > 45… similar to my ‘Paunch” buy setup.

2) When price closes below an X bar lower Keltner band, buy long
3) Place a stop to sell on a limit at the X bar upper Keltner band… this will keep changing.
That’s all there is to it. No stops are used but you may want them based on your comfort level with
the company you are buying.
There are no perfect Keltner band settings. I actually like to tailor it to the item I am trading when
looking for a buy signal. Generally speaking I suggest you use an 18 day band with a 1.8 setting.
How to Trade Holidays
The definitive guide to trading the holidays; uncovering the best, the worst and
detailing entries and exits.
Everything you ever wanted to know about these very strong short term market
influences.
In his seminal book, “Behavior Prices on Wall Street”, Art Merrill seems to have presented traders
with the first serious study of market activity around holidays. The data from 1897 through January
1966 made it clear; markets tend to rally before holidays.
I was fortunate to know Art and in fact I am quoting from his book inscribed to me in March 1968,
wherein he says, “The days preceding a holiday is usually a good day. The market has risen two
thirds of the time. In the case of a long holiday, the market has risen 71.8% of the time. These ratios
are highly significant. It would be exceeded by chance, only once in several thousand repetitions in
the 69 years history.”
When Art did his work we had fewer holidays than we do now. We had Washington’s Birthday,
Good Friday, Memorial Day, Independence Day, Labor Day, Election Day, Thanksgiving, Christmas,
and New Year’s Day.
We no longer have a holiday before elections, which ended in 1984. We have added Martin Luther
King Day and for some markets, Columbus Day has become a holiday.
In 1986 another friend, Marty Zweig, wrote another seminal book, “Winning on Wall Street.” It was
my pleasure to write a promotional blurb for Marty’s book, unfortunately both Marty and Art are no
longer with us.
Writing about holidays, Marty said, “What I found, however, is anything but normal. Rather, price
trends near holidays are extraordinarily bullish, shattering the myth espoused by many academicians
that stock price movements are random. Moreover, it is nearly certain that these patterns are
attributable to the emotionalism of investors.”
I have covered holiday trading opportunities in many seminars and the books I have written as well.
I thought however, it is time for someone to do a definitive guide to holidays… carrying forward Art
Merrill’s work to fill in the blanks of the last 50 years.
While Merrill’s and Zweig’s (and Yale Hirsch’s) work discussed trading opportunities in the stock
market, I have found similar bullishness occurs for bonds as well as gold. My general observation
is that prices are bullish leading up to holidays and bearish after holidays. That is the same general
observation Merrill made in his writings. However, there are some exceptions as I will explain in a
yet to be published report.
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In each potential Holiday trade I am buying on the opening of N number of days before the holiday.
The exit is to hold for one day, then exiting on the first profitable opening or on a $2,400 stop
(whichever comes first).
You may choose to vary the exit and entry approaches yourself. I wanted to standardize our entry
and exits so we can see across markets how strong the seasonal influences.
For consistency I have also used TradeStation on all of the tests you will be reviewing. I use their
software, their data and how they handle holidays. I do need to point out that various data providers
and software vendors handle trading days before and after holidays differently based on their
definition of a holiday. My definition is simple; a Holiday date is used and we buy on the open of the
Nth day prior to the holiday.
Chart 62
The above chart reflects buying on the day before all holidays, using a $2,300 stop in the
E-Minis. Why a $2,300 stop? As you will note in the next chart, I tested various levels of stops and,
by and large, that has been the best.
Chart 63
With the above in mind, let’s develop the best trading strategy for each of the 9 trading holidays of
the year.
Stocks Start the New Year with a Rally
Stocks rally at the first of the year as we can see from the next clip of the last 12 years in the S&P
E-mini contract.
In this instance I am using a $2,300 stop loss. A close study of the following table shows buying five
days before the holiday is the most successful with over $5,000 in profits. 16 out of 16 trades were
successful, good odds for speculators like me and you.
Chart 64
The E-mini has only been an active contract for the last 12 or so years. So let’s take a look at the
large contract, the pit session, which started trading in 1984. Does it show a similar holiday pattern?
$3,500 Stop Tested

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Chart 65
The answer is clearly yes. In this case I automatically tested a $3500 stop, the approximate stop
I used during that time in my actual trading. Buying one day before the New Year’s holiday was
successful 75% of the time, making almost $30,000.
There is the potential for a short sale after the year begins to trade, as we can see from the next clip.
Chart 66
It has also been profitable to sell on the 3rd day after the New Year, with 10 winners in the last 11
years.
Martin Luther King Second Holiday of the Year
The second holiday of the year was first observed in 1986 after President Ronald Regan signed
legislation creating a holiday in the honor of a private citizen. The only other private person to attain
such status was Christopher Columbus. The holiday takes place on the third Monday of January,
which is usually close to Dr. King’s January 15th birth day. This holiday was not officially observed
in all states until 2000.
We have a relatively limited amount of data points for this holiday, yet there appears to be a tradable
event here.
Chart 67
Buying on the day before the holiday has made money 81% of the time, but you should pay attention
to the average profit per trade. That sits at a nominal $145.
With that in mind let’s look for a short sale before this day off of trading. There is more money to be
made on that side of the market based on the next clip. Now, does the holiday cause the decline or is
this a seasonal influence at work? I would suggest it is the seasonal.
Chart 68
Selling on the 6th day prior to the holiday or even the day before looks like the best strategy.
Third Holiday of the Year…Presidents Day
Some might think the third holiday of the year is Super Bowl Sunday, given the amount of people
that party up for that weekend. The actual holiday, Presidents Day is less exciting.
This is an ‘underwhelming’ holiday when it comes to stock prices.

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Chart 69
As the above clip shows, there is weakness before this holiday, one of the few that looks this way.
The best trade is to buy 3 days prior, with 15 out of the last 16 years netting profits. The rally
appears to begin 4 to 5 days prior to Presidents Day. So traders should be looking for, and taking,
buy signals at that time.
Fourth Holiday of the Year…Good Friday
Unlike Martin Luther King and Presidents Day, the Good Friday holiday is celebrated throughout the
world. Does that make a difference? It sure looks that way.
Chart 70
Just look at the residual rally one day before the holiday; 15 out of 15 winning years. Got your
attention? News to you? I hope so, but this is old news. Art Merrill’s work noted that from 1897 to
1966 prices rallied 60% of the time on the day prior to Easter.
I suspect my exit technique would make his numbers show a higher accuracy. Clearly this is a trade
to get your attention.
Fifth Holiday of the Year…Memorial Day
Chart 71
Memorial Day is not what it used to be. In the Merrill work, the day before this holiday was up
78% of the time. That has not been true since 1998. The 2000 - 2002 bear market was not inductive
to rallies at this time. Since 2003, buying one day before the holiday has always been a profitable
strategy.
Sixth Holiday of the Year…Fourth of July
Chart 72
The next holiday celebrates the founding of the United States of America’s independence. The
country is awash with red, white and blue bunting, flags waving and usually a rally in the stock
market.
As you can see in the chart above, prices have rallied 81% of the time the day before this holiday.
Yet, the money is made buying earlier, about 4 to 5 days before the holiday. There the average trade
jumps up to $328 and $399. It is another trading hot spot with a 93% success rate. Celebrate the 4th
buy being bullish on America and our stock market!
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Seventh Holiday of the Year…Labor Day
The first Labor Day was celebrated in New York City on September 5, 1882 and was started by the
Central Labor Union in New York City. In 1884, it was moved to the first Monday in September
where it is celebrated today.
Labor Day, essentially a Union Holiday, was set in stone as a National Holiday on June 28, 1894
when U.S. congress deemed it a national holiday. There is lots of market history on this one. Merrill
suggested an 80% rally on the day before Labor Day. Non Union members, and there are far more of
them now than when this became a holiday, see this as the pivotal and official end of summer.
Chart 73
This is still a bullish holiday with a rally 75% of the time the day before the holiday. As you can see,
though, there is a better time to buy; about 3 to 4 days before, where the profits step up as does the
accuracy.
A New Country, a Lost Holiday?
History books and scholars sure miss a point when they tell us Christopher Columbus discovered
America. How about the natives that were living here? What were they, the lost tribes? We now
know for fact that Nordic explorers had travelled down the eastern coast of Canada, while there are
pyramids or mounds with a South American influence in Michigan and Wisconsin; all this taking
place long before Columbus was born.
The ruins of Cahokia outside of St Louis Missouri are a good example. Dating back to 1100, they
were first written about by Henry Brackenridge, a lawyer and amateur historian who came upon
the site and massive central mound while exploring the surrounding prairie in 1811. “I was struck
with a degree of astonishment, not unlike that which is experienced in contemplating the Egyptian
pyramids,” he wrote. “What a stupendous pile of earth! To heap up such a mass must have required
years, and the labors of thousands.” No wonder it is estimated this was actually a city of some
100,000 people.
Today, we celebrate Columbus Day for what it accurately is; he did discover the existence of the
New World for Europeans who until then, believed the world was flat and ended somewhere in the
Atlantic. The focus is more upon discovery of the “New World”, and less upon Columbus himself.
On his second voyage to the new world his first stop was here on St Croix where we live. On seeing
the island, and what he wrongly thought was a river of fresh water, he sent 3 crew members out in
a small boat. The local Arawak Indians quickly killed them. The Arawaks came here about 100 AD,
from South America. Tourists are treated a little better these days.
The only market that is officially closed for this day is the Bond market.
Eighth Holiday of the Year…Thanksgiving
The first Thanksgiving was celebrated between the Pilgrims and the Indians in 1621, as a sign of
thanks and friendship. How that changed as the settlers moved west, liberating the Indians land for
themselves. Though, to be fair, in many instances the tribes sold their land rights for money, guns,
etc.
That first feast took three days, a tradition most still try to honor by shopping. The original holiday
was also a time of prayer, thanking God for a good crop. Now it has become a time to thank God for
an uplift it stock prices!
Chart 74
That’s a pretty picture in the above table, a cluster of 100% correct trades buying 1 to 2 days before
this holiday. Impressive! It looks like the rally starts about 3 days out, then really builds up a head of
steam. Why does this happen so consistently? It might well be the shopping frenzy the nation whirls
into and the usually bullish stories about Christmas sales on the retail level.
If you doubt that then consider the next clip buying WalMart on 1 through 6 days before
Thanksgiving, the Super Bowl for retailers.
Stock Trading | 59
Chart 75
Pretty awesome; 100% of the time in the last 37 years there has been a profit. I am using a $3 stop
from entry and our ‘Bail-Out”, exiting on the first profitable opening. Most likely there is a more
profitable opening, that’s a good task for all of you WalMart shoppers. It sure looks like there is an
option opportunity here.
Ninth Holiday of the Year…Christmas
Of all the markets studied, the stock market represented by the S&P E-mini contract has shown
the greatest propensity to rally before Christmas. There were $10,125 profits from buying on the
day before Christmas in the last 17 years. The strategy has been profitable in each instance using a
$2,300 stop or the exit technique described above. Buying two days before Christmas has also done
well, showing $8,850 in profits. But there was one losing trade. Going long on the third day before
the holiday has seen 16 winning trades in the last 17 years.
Chart 76
I sense it is noteworthy that here, again, we have a holiday celebrated throughout the world. There
are three of these: New years, Easter and Christmas.
Start the New Year Off With a Winning Bond Trade
Traders can start the year off with what appears to be predictable rallies in the stock gold and bond
market.
We need to know an optimal stop. To arrive at that, I tested the last 13 years (Chart 77) and we see
the ideal stop loss is $1,800 per contract.
Chart 77
With that over, let’s beat up the bond market to see if there are holiday influences at work here.
I began delving into this in the mid 1980’s (to my knowledge no one had looked into this before) and
believed then and still do today, that there are some really great trades here.
In the Chart 78, you will note that buying three days before the January 1st holiday has made over
$17,812, with 34 out of 36 trades being successful using a $1,800 stop loss.
Those are pretty good odds I would say. Just look at what we uncovered… a holiday trade for bonds
at the first of the year!
Stock Trading | 61
Chart 78
Chart 79
Buying 4 days before this holiday sports an 88.89% accuracy, enough to attract my attention and
suggest a trading opportunity. 32 out of 36 winning years seems like something is happening on a
repetitive fashion.
Chart 80
Here we have a day for bond traders to skip or be there for a short sale. In the last 36 years the better
side to be on has been the short side.
From 1992 forward the results are dramatically different.

Chart 81
There is a trade here, prior to the holiday, that’s for sure.
Chart 82
Easter doesn’t offer up much for bond traders, unless they want to sell short. So let’s take a look at
what we can learn from selling X days before Good Friday.
Chart 83
Hmm…this looks pretty strong. 30 winning years out 33 for 90% accuracy and an average profit of
$696.
Stock Trading | 63
Chart 84
I like the cluster of bullishness here. Buying 4, 5, or 6 days prior to Memorial Day all make money
with an accuracy over 80%. This does raise a penetrating question, does the holiday “cause” any
price action? This is marginal, as I see it, because what we should see is strength prior to the holiday.
Here we have a very mixed bag.
Chart 85
The July 4th holiday looks better, much better. We see a large cluster of profits leading up to the
holiday with over 80% winners. Clearly traders want to be taking longs a few days before the
holiday and be out before as well.
Chart 86
Look at the best day here, day 5, and then look at the average profit per trade. Only $123, too low to
trade for.
I next tested the last 13 years and found this:
Chart 87
Again day 5 is the best and this time the accuracy is excellent, while the average profit per trade is
$932. Bottom line; I look forward to taking buys 5 days before Labor Day.
Stock Trading | 65
Chart 88
The results look so choppy here. Only day 6 does well with 91.98% winners and a nice average
profit per trade.
I ran just the last 13 years of data. Here are those results:
Chart 89
It looks like a pretty mixed bag.
Let’s see if there are any bond trades as presents under out Christmas tree.
Ninth Holiday of the Year…Christmas
Chart 90
This is more like it! I love that 91 % accuracy, 33 out of 36 winning years.
Looking at more recent data we see similar results.
Chart 91
Bottom line here is Santa delivers us presents every year. Look for bonds to start a rally the day prior
to Christmas.
Stock Trading | 67
Start the New Year Off With a Winning Gold Trade
As the man on Fox News says, “We report, you decide”. Here are the trading day tests for gold for
each of the nine holidays. In all tests a fixed $2,500 stop loss was used.
Gold has a reliable pattern to rally starting the first trading day of the year. The following clip,
which goes back 40 years, shows that buying on the day before the New Year’s holiday has been
successful 87% of the time, making $19,880.
Chart 92
Again, as we saw earlier, the correct stop is critical, shown in the next tabulation. Again it buys on
the first day after the New Year’s holiday. Stops were run from $1,300 to $3,500 on the last 12 years
of data to help you determine what stop best suits you.
Chart 93
Chart 94
Stock Trading | 69
Chart 95
Chart 96
Chart 97
Chart 98
Chart 99
Chart 100
Stock Trading | 71
Christmas…A Golden Opportunity
The Best Christmas Trade For Gold
Let me explain the following table… Williams Holiday Test is the column you will want to first
study. Test 1 means you would buy on the opening of the day prior to the holiday. In this case with
gold (in the last 12 years) you would have had 11successful trades, one loser and netted $8,690. Had
you purchased four days before the holiday, you would have only made $2,380.
Chart 101
Sure looks promising… so I took the data back as far as TradeStation has Gold prices; January 1975
- 37 years of data. We get these results:
Chart 102
These tabulations give a very nice and clear-cut look at how many days prior to a holiday to enter the
market. Obviously it does matter how many days before a holiday you purchase gold. It looks like
5 days before is the best. I would bet my bottom dollar on the fact, few if any gold traders have ever
been aware of the strong seasonal pattern for gold to rally one or two days before Christmas. That
95% accuracy is very tough to beat in the world of real trading.
But there is a problem there…how can there be 38 trades in 37 years? (2013 is not in the test).
Hmmm…that bothered me…a great deal.
So, I visually checked every trade, every December form 1975 forward and found a problem in the
data from TradeStation, as we as all the other data providers.
In this market sometimes they show no trading on the 24th of the month. If it was a Monday it was
treated as a holiday despite the fact the market was open and trading. Thus, the above results only
give a general idea of the best trade day to buy.
I had to go through the data by hand and based on that search, here is my conclusion for trading gold
before Christmas…
1. The most certain trade is to buy the day before the holiday and exit on the first
profitable opening. This trade has lost twice since 1975.
2. The next best trade is buying on the opening 4 days before the actual Christmas
holiday.
Now... Onto Some Special Bonuses!
Disclaimer

Stock Trading | 73


Larry Williams
Stock Trading and
Investing Course
Part 4
A comprensive guide
the right stocks at
the right time.
Part 4
Bonus Report
Contents
The Best Stock of the Last 50 Years 4
The Secret of Bottom Picking 5
Ultimate Top and Bottom Index 8
Cancel Your Subscription to the Wall Street Journal 10
The “Fed Model” 12
How to Invest 15
Insider Buying 19
Consumer Opinion Surveys 21
One Indicator Accounts For 50% of Annual Earnings 22
High Levels of Unemployment are Bullish 23
The Politics of Deficits in the Stock Market 24
The Federal Reserve Forecast of the Future 25
Wrap Up 26
Disclaimer 27

Investment
Gems
Here they are... 12 special bonuses you will treasure throughout the years.
These are investment gems to help improve your depth of understanding as
well as provide insight into some excellent buy and sell indications.
- Larry Williams
Williams.
4 | Larry Williams Stock Investing Course
Bonus # 1 The Best Stock of the Last 50 Years
The tremendous impact of fundamentals has been given a great boost in Jeremy Siegel’s new book,
“The Future for Investors: Why the Tried and True Triumph Over the Bold and the New.” The unex-
pected conclusion: It's not the hot, new-industry stocks that serve investors best. More often it's the
humdrum, traditional firms that sell cigarettes, pump oil or peddle soft drinks and chewing gum.
Siegel concluded that investors can improve on index-style investing by also holding stocks with low
price-to-earnings ratios and high dividend yields, and by putting as much as 40% of their stock port-
folios into foreign issues.
“Indexing is great,” he said in an interview. “But now, after doing all my research, I think we can do a
little better.” A proper mix could boost annual returns to one or two percentage points above those
provided by indexing, he noted.
WHAT’S THE NUMBER ONE STOCK OF THE LAST 50 YEARS?

For his new work, Siegel searched through the Standard & Poor's 500 Index to find patterns among
the winners and losers. “I was frankly shocked that Philip Morris would be the number-one stock,”
Siegel said. “I would just never have guessed that. I would have said, 'Maybe IBM.'” From 1925
through the end of 2003, tobacco company Philip Morris, now called Altria Group, delivered a 17%
average annual return, assuming all dividends were reinvested in the company's shares. That beat the
average stock by 7.3 percentage points per year. A $1,000 investment in Philip Morris in 1925 would
now be worth more than a quarter of a billion dollars.
Similarly, consider a choice available to an investor in 1950 who could have put money into the most
cutting-edge company of the day, computer maker IBM, or the numbingly ordinary Standard Oil of
New Jersey. Even today, most investors would assume IBM was the best bet. Indeed, according to the
most widely watched measures of growth, IBM was the winner over the next 53 years, dramatically
outstripping Standard Oil in per-share growth of revenue, dividends and earnings.
IBM, MICROSOFT OR STANDARD OIL?
But Standard Oil shareholders did better, with average annual returns of 14.42% versus 13.83% for
IBM. That half-point difference, compounded over 53 years, put the oil-company shareholders ahead
by more than 25%. A $1,000 investment in Standard Oil would have grown to $1.26 million, com-
pared to less than $1 million for an equal investment in IBM.
Siegel found similar results again and again. Since 1950, the top-performing companies were Na-
tional Dairy Products (now Kraft Foods), returning 15.47% a year; R.J. Reynolds Tobacco 15.16%;
Standard Oil of New Jersey (now Exxon Mobil) 14.42%; and Coca-Cola 14.33%. A $4,000 investment
in the top four would have grown to $6.29 million, versus $1.11 million for a similar investment in
the stock market as a whole.
The “Growth Trap”

What causes the out-performance of the prosaic old-style stocks over the more exciting trailblazers?
“The answer is simple,” Siegel writes. “Although the earnings, sales and even market values of the new
firms grew faster than those of the older firms, the price investors paid for these stocks was simply too
Bonus Report | 5
high to generate good returns. These higher prices meant lower dividend yields and therefore fewer
shares accumulated through reinvesting dividends.”
Siegel calls it the “growth trap” - investors' tendency to pay too much for shares in fast-growing com-
panies, largely because they expect too much growth in the future. From 1950 through 2003, IBM
shares sold at an average price 26.76 times annual earnings, while Standard Oil traded at 12.97 times
earnings. IBM's dividend yield (annual dividends divided by share price) was 2.18%, while Standard
Oil's was 5.19%.
The higher dividend yield allowed Standard Oil shareholders to accumulate many more shares, caus-
ing returns to snowball. “Dividends matter a lot,” Siegel writes. “Reinvesting dividends is the critical
factor giving the edge to most winning stocks in the long run... The return on stocks depends not on
earnings growth but solely on whether this earnings’ growth exceeds what investors expected, and
those growth expectations are embodied in the price-to-earnings, or P/E ratio. Portfolios invested
in the lowest P/E stocks in the S&P 500 Index returned almost 3% per year more than the S&P 500
index, while those invested in high-P/E stocks fell 2% per year behind the index.”
Bonus #2 The Secret of Bottom Picking
It’s fun, it’s dangerous… it can be easy and profitable!

More money has been lost trying to pick the exact low (or high) point of a move than any other tech-
nique. Yet we all (except me, I really do practice what I preach) want to get in as close to the low as
possible. Even then, if we are correct on the time, the issue is to buy the stocks most likely to go up.
Friend Tom McClellan, yup, Sherm’s son, made some very interesting comments about what stocks
are most apt to lead the way off a market bottom. (http://www.mcoscillator.com) He has graciously
allowed me to reprint his comments here.
“Does one choose the strong stock/sector, or the weak one, figuring that the most beaten down issues
might be the ones to claw their way back the fastest?
Since I had the data, I took a look at the stocks which make up the NASDAQ 100 Index, for the
period fom July 2001 to Dec 2004. I intentionally picked obvious and perfect oversold conditions,
and assumed absolutely perfect market timing for the purpose of this historical study. These were
not actual trades, and there are several assumptions that should be called into question in this study
in comparison to how one might actually trade. But I thought that the methodology was suitable for
testing the leaders/laggards question which was posed.
In this time frame there were 5 episodes that I studied of either an initial or a terminal reading be-
low… oversold reading… and then the rally which followed. Those instances and results are sum-
marized below. I looked at the stocks which make up the NASDAQ 100 Index, and wanted to see
what happened after an oversold bottom. Was it the most oversold issues, or least oversold, which
did the best from the oversold bottom until the succeeding top?
To define the groups (most oversold or least oversold), I looked at the percentage drawdown in each
stock from its 52-week high. Out of the 100 stocks in the NDX, I examined the 10 stocks with the
biggest draw downs from their 52-week highs as well as those with the smallest draw downs of the
day of the most extreme oversold reading. The results are as follows:
NASDAQ 100 Index Oversold Study

Bottom: 09/21/01 Top: 12/05/01 NDX gain: 52.7%
Smallest 10 draw-dns Avg Gain: 25.01% Lowest Gain: 3.74% Biggest Gain: 45.10%
Worst 10 draw-dns Avg Gain: 70.30% Lowest Gain: -55.80% Biggest Gain: 376.06%
Smallest 10 draw-dns Avg Gain: 5.21% Lowest Gain: -8.20% Biggest Gain: 18.86%
Worst 10 draw-dns Avg Gain: 15.27% Lowest Gain: -26.52% Biggest Gain: 51.56%
Worst 10 draw-dns Avg Gain: 137.93% Lowest Gain: 0.58% Biggest Gain 386.57%
Smallest 10 draw-dns Avg Gain: 41.28% Lowest Gain: -1.21% Biggest Gain: 85.13%
Worst 10 draw-dns Avg Gain: 40.83% Lowest Gain: 5.00% Biggest Gain: 116.07%
Worst 10 draw-dns Avg Gain: 46.18% Lowest Gain: 3.15% Biggest Gain: 145.28%
Table 1: NDX Most/Least Oversold Study
In each of these perfectly chosen cases, the 10 stocks with the worst draw downs had the best perfor-
mance coming out of the bottom and measured until the succeeding top, as compared to the stocks
that were holding up the best into the bottom.
Thus the conclusion is that if one believes an oversold bottom is at hand, the best strategy is to buy
a group of the most damaged issues and eschew the ones that have been holding up the best. That
point about buying a group is important, given the wide range of performance among these biggest
loser issues. This is a buy for a bounce, not a long term hold!
This makes sense when one thinks of the abstract concept of ‘beta.’ Certain stocks will move more
than the average stock, and certain other stocks will move in smaller increments. A stock with a beta
Bonus Report | 7
of 2.0 should move 2% on any given day that the ‘market average’ moves 1%. Of course we know
that such a measure is imperfect, but it is a good model for understanding what stocks do the best
coming out of a bottom. If a high beta stock moves true to form, it should decline most strongly into
an extreme oversold bottom, and should also move upward most strongly out of that bottom. Thus,
it is the high beta stocks which should to do the best in a bounce out of an oversold bottom.
That very conclusion brings us back to the problematic but inherent assumption in this study, which
holds that one can correctly identify the very date of the oversold bottom as well as the proper top
which follows such a bottom. That is a hugely problematic assumption, but if one is willing to ac-
cept that premise and dive in, then the most oversold (and therefore highest beta stocks) seems the
best to buy at such bottoms.
As a caveat to that, there is a much wider range of returns in the higher beta issues coming out of
such a bottom, so diversifying among a plurality of such issues may protect one from the risk of
further high-risk declines.”
Tom’s study dovetails with what I have reported in my moving average studies; that high relative
strength stocks are not the best to buy at the bottoms.
It’s Biblical. I told Tom, “the first one now shall later be last.”
A TEST OF COMPARATIVE STRENGTH
While Tom looks at NASDAQ stocks, we only look at the Dow 30 which made the next test much
easier. I wanted to nail down this idea of “Comparative Strength” once and for all. The idea is
simple; when the market makes a bottom, buy stocks that do not make a corresponding low.
Chart 1: Home Depot vs the Dow

Chart 1 of Home Depot says it better than I ever could. Note how at the 2003 low as well as the
2004 low CAT failed to go to new lows while the Dow 30 broke down. “Compared to” the Dow,
CAT was stronger. The holders of the stock did not panic during a market sell off, telling us the
stock was in strong hands.
I went back and hand checked all 30 Dow issues at the 2003 low, looking for comparative strength.
I was able to only find 11 that were clearly stronger, looking at just the recent lows rather than the
Dow itself. I then did the same thing for the October 2004 low where I was surprised to find 21 of
the 30 were showing they were stronger than the Dow. Like in Tom’s study, this is all based on the
past and I “bought and sold” at the close of the highest and lowest week in the Dow. Optimal tim-
ing, but the purpose was to see if there was a difference. There was… and yet there are problems…
the dang guys at the Dow keep changing the components, making it a little hard to go back in time.
However, the results from these two lows are illustrative of what I have been lecturing about for
years and years… Comparative Strength is a good selection tool.
2003 Low 2004 Low

Dow Gains 31.6% Dow Gains 9.2 %
Comp Stocks Gain 48.2% Comp Stocks Gain 10.6 %

Table 2: Dow Comparative Strength 2003 & 2004
Bonus #3 Ultimate Top and Bottom Index
The Federal Reserve Bank of St Louis publishes a wealth of information for watchers of the econo-
my. One of their seldom discussed charts is a basic tabulation of all the money in the world defined
as:
((Nonfinancial corporate business; corporate equities; liability, Level+Financial business; corpo-
rate equities; liability, Level)/1000)/(((Nonfinancial corporate business; corporate equities; liabil-
ity, Level+Financial business; corporate equities; liability, Level)/1000)+Nonfinancial Corporate
Business; Credit Market Instruments; Liability+Households and Nonprofit Organizations; Credit
Market Instruments; Liability, Level+Federal Government; Credit Market Instruments; Liability,
Level+State and Local Governments, Excluding Employee Retirement Funds; Credit Market Instru-
ments; Liability, Level+Rest of the World; Credit Market Instruments; Liability, Level)
Yes this is more than a mouthful, but it does present a great indicator telling us when to expect major
declines and rallies. When this gauge is greater than 0.45, stocks are headed for real trouble. When it
is below 0.25; mortgage all you have and go long equities.
Here is a link to this powerful tool: http://research.stlouisfed.org/fred2/graph/?g=qis
Bonus Report | 9
Chart 2: All the Money in the World 1950 to 1990
Chart 3: All the Money in the World 1990 to 2015

Bonus # 4 Cancel Your Subscription to the Wall Street Journal
VIEWS ON THE NEWS... Offering evidence that the 80/20 rule is alive and well when it comes to
the media mavens of finance.
“But Larry, what if the Fed does something, like a change in rates or there’s some big news an-
nouncement… won’t the market blast away?”
That’s a question I’m frequently asked, and have usually replied, “Well, you know these systems we
develop are not based on news events or releases. So, I just trade “through” the news, taking my
lumps as they come.” That always made sense to me, but now it makes even more sense in light of
a study I read by David Cutler, James Poterba and Lawrence Summers. Their study, “What Moves
Stock Prices” looks at stock price returns from 1926 to 1985 measured against economic news.
In short, what they looked for was the release of certain economic news and then noted how much
price change was associated with the news releases for seven key areas:
Real dividend payments

Industrial production
Real money supply (m1)
Long term interest rates
Short term interest rates
Monthly CPI rates
Market volatility
I’ll skip the entire mathmatical explanations of the report. These guys are MIT and Harvard profes-
sors and, typically, speak in college talk which does not get right to the issue. The halls of academia
are lined with large words. For the life of me, I cannot figure out why they won’t write like we
speak.
Anyway, one of the gems of their study is this: “Macroeconomic news… explains only about one-
fifth of the movement in stock prices.”
The authors put forth some very revealing information about news and stock prices. My favorite is
their finding that an unexpected increase of 1% in real dividends raises share prices by about one-
tenth of 1%. As we know, dividends matter... to an extent.
They note that a 1% increase in industrial production causes four-tenths of 1% increase in stock val-
ues. News then, does matter, but not much… less than 1%. This may help us to better understand
the day to day hum drum of financial news from the talking heads and market maven crowd.
While the Wall Street Journal, or Drudge, makes much to-do about these reports, the professors’
studies suggest the impact is rather limited.
Bonus Report | 11
BIG NEWS AND BIG MOVES --- ARE THEY RELATED?

Now, on to the bigger question. Do big news events make for big market moves? The results of the
Profs’ studies drive home several points we would-be speculators should be aware of. The average
stock market follower, cock-tail chatterer type, will surely talk about the big news announcements
and their impact on stock prices.
The study researched the major stock market moves of the last 50 years to see what news announce-
ments were present at the time of the moves.
I love this! Finally, someone took the time to look at the most major up and down moves to see if
they were jump-started by news. Their conclusion: “It is difficult to link major market moves to the
release of economic news… or other information.”
Certainly there were days where the markets were moved by the news; Ike’s heart attack, JFK rolling
back steel prices, and the Iranian attack on Kuwait on October 22, 1997. Yet, there were more days
of large moves---up and down---when there was no news found in the New York Times that would
account for stock market movement. Again, the 80/20 adage seems true. 20% of major market
moves can be explained by news, 80% cannot.
The worst one day decline in the last 50 years was October 19, 1987 when the press reported that,
“worry over the dollar decline and fear of trade deficits” triggered the crash. Standing on their own,
these words are meaningless and have been written many times before without an ensuing crash.
Here’s what the Times reported as the “news” of the day on the largest rally days in the last 50 years:
News of the Day

% Move Date Reason in NY Times
+9.10 10/21/87 “Interest rates continue to fall…”
+5.33 10/20/87 “Investors looking for quality stocks…”
+5.02 5/27/70 “Rumors of change in economic policy…”
+4.70 8/17/82 “Interest rates decline…”
+4.65 5/29/62 “Optimistic brokerage letters…”
+4.60 10/9/74 “President Ford to reduce inflation…”
+4.49 10/23/57 “Eisenhower urges confidence in the economy…”
+4.46 10/29/87 “Deficit reduction talks begin…”
+4.19 10/7/74 “Hopes Ford will announce inflationary measures...”
+4.08 7/12/74 “Lower inflation, reduction in loan demand…”
+4.01 10/15/46 “Meat prices decontrolled, prospects for others…”
Table 3: NY Times Headlines on Largest Rally Days Over 50 years
The only thing I see in common is that 7 of the 11 best rally days took place in October!
Keep in mind newspapers largely exist to sell advertising, and in order to do that they need to fill up
the pages with “news.” Hence, whatever happened on a given day must be “explained away” to at
least make sense or bring some rationality to the events of the day. In hindsight, any cub reporter
can drum up some news about why the market moved. Nonetheless, what the profs found was that:
“On most of the sizeable return days, however, the information that the press cites as the cause of the
market move is not particularly important.”
Their conclusion was that, “most of the variations in returns for individual stocks cannot be ex-
plained using readily available sources of news information.”
My 40 plus years of trading and reading newspapers confirms this study!
Bonus #5 The “Fed Model”
One of the most helpful tools in calling the 2002 market low was what has become known as the
“Fed Model.” This model is how supposedly the Federal Reserve values stock prices and acts and
reacts accordingly, with money supply, interest rates and so forth.
The index has been popularized by Ed Yardeni. The work of Laurel Kenner and Victor Niederhoffer
efforts and research have brought forth most of what follows.
For many years investors have looked for a relationship between stock and bond returns. The “Fed
Model” is a spin off of that thesis. The following is a white paper from Tom Downing. It is based
on the Kenner/Niederhoffer work and wraps up our understanding of the model (pros and cons) in as
concise a fashion as I have seen.
“Similar in spirit to the Stock-Bond Ratio is the “Fed Model”, which postulates a relationship be-
tween market returns, P/Es, and bond market yields.
It has been thought to be used by the Fed itself and was originally named and extended by Dr.
Edward Yardeni. Some (such as Clifford Asness, founder of the $10.5 billion AQR Capital Manage-
ment in "Fight the Fed Model: The Relationship Between Stock Market Yields, Bond Market Yields,
and Future Returns") have argued that the Fed Model is theoretically unsound.
While we think that the Fed Model is far from bulletproof, we feel that it is a useful tool in our mar-
ket timing toolbox. The main point of the Fed Model is that, if the forward earnings yield of the S&P
Index is higher than the 10 year treasury yield, stocks are “undervalued“ and vice versa.
If expected earnings yield is lower than what you can earn risk-free on a ten-year bond, it does not
pay to hold stocks, while if S&P yield is higher than 10 year note, then investors are receiving a pre-
mium for taking the additional risk inherent in stocks.
Analysis
We used year-end 12 month “forward” earnings (available from Thomson via Prudential) and in-
Bonus Report | 13
terest rates from 1980 through 2003 to study this relationship. A convenient way of looking at the
relationship is to estimate the Fair Value of the S&P 500 by dividing forward S&P Earnings by the
current 10 Year Yield.
If this Fair Value is less than the current value of the index, then the S&P is considered overvalued
and vice versa. For example, the current S&P is at 1113, expected earnings for the next year for the
S&P 500 are 67.62 and the current yield on the ten year T bond is 4.45 percent.
Use the T bond yield as the discount rate for Forward Earnings to calculate Fair Value: Fair Value
= Fwd Earnings/10 Year Yield = 67.62/.0445 = 1520. Then divide Fair Value by the current index
reading to determine under/over valuation: 1520/1113-1 = 36% implied expected return. We then
compare this implied return to the realized S&P performance over the subsequent year.
Chart 4 shows a scatter plot of this relationship for the years 1980 through 2003. The correlation of
this implied expected return and the subsequent actual return is 0.42. Encouragingly, splitting the
data into two time periods (1980-1991 and 1992-2003 respectively) yield correlations of greater than
0.40 in each of the periods, indicating a relatively stable relationship through time (although with
admittedly small number of observations (12) in each sample).
Chart 4: Actual Return vs Feb Model Expectations

Market Timing
Expected Returns implied by the Fed Model were generally positive throughout the 1980s, as were
stock returns. The model turned negative in 1997 and indicated a particularly strong overvaluation in
2000, the year in which the tech bubble finally burst. If one were to have strictly adhered to the Fed
Model as a market timing tool, one would have expected markets to rise in 2003 and one would also
have stayed away from the market in 2000, 2001, and 2002 thereby avoiding a 40 percent draw-
down. But one would also have been out of the market in 1997-1999, when the S&P 500 returned
98 percent.”

Chart 5: Fed Model Predictions and Subsequent Returns
This report was written in July 2004 and produced the following forecast. You can
check to see how it came out.
“Current Forecast 7/9/04

We have found that the best way to specify the Fed model relationship for forecasting purposes is in
the form: S&P Return [t+1] = a + b * (Forward Earnings Yield [t+1] - 10 Year Yield[t]) Estimating
a linear regression of the form above, we obtained the following equation:
S&P Return [t+1] = 0.089 + 5.803 * (Forward Earnings Yield [t+1] - 10 Year Yield[t])
Stats 2.77 2.23
P-values 1.11% 3.63%
Bonus Report | 15
The adjusted R-Squared of 0.147 is quite high for a predictive regression in the financial markets and
indicates that almost 15 percent of variation in subsequent returns was explained by the independent
variable over the time period studied.
To determine current Fed Model forecast:
1. Current S&P (as of 7/9/04) stands at 1112.8
2. Fwd.Earnings = May 2003 12 months forward earnings for the S&P 500 = 67.62
3. Forward Earnings Yield = Fwd.Earnings / S&P = 67.62/1112.8 = 6.08%
4. 10.Year.Yield = The Current Yield on 10-Year Govt Bond is 4.45%
Substituting these numbers into the regression formula : 0.089 + 5.803 * ( 0.0608 – 0.0445 ) = 18.4
%.
Therefore, Fed Model yields a forecast of about 18.4% for next 12 months.”
NOTE: A real note of gratitude goes to Victor, Laurel and Tom for allowing me to share this infor-
mation with you. As I said earlier this model or index has been very helpful to me. Mostly it has
shown me value when the Gods of Fear walked the streets. When fear prevails it is very hard to step
in and buy stocks. The help has come when seeing a massive sell off, while at the same nice being
slapped in the face when this index saying, “wake up, stock prices are undervalued… you better do
something about it pretty soon.”
I do not see the model as a timing tool or some “be-all-end-all” panacea. Its purpose is to expose
areas of potential good and bad times, and as you can see it has a good record of doing just that.
Bonus #6 How to Invest
How to invest? Awe come on… we know how to invest Larry. We want to know
what to buy and when.
While the right stock at the right time is important, so is how you invest in those stocks.
Let me explain. Our resident PHD trader, proof-reader Mark Bruels and I have had some discussion
regarding how we plunk our money down into stocks. Should we buy the same number of shares of
each Darling of the Dow or put an equal amount of money into each stock.
It boils down to this investment question: equal shares or equal dollar amounts? Here is how Mark
approached the problem.
Same Dollars Per Position vs Same Shares Per Position

“I think the tendency is to favor the Same Dollars per position because this gives more shares to the
lower priced stocks which “should” go up more in a rising market, and I presume we are in a rising
market. That assumption can be seriously questioned, of course.
If you do the algebra in a general form, you get the relationship (Sum of Initial Stock Prices) X (Sum
of Price Changes)/ (number of stocks) > < = (Sum of Each Stock Price X Change for that Stock). I
put > < = to indicate that this is the relationship we want to know. If the > is taken, it means the
Same Dollars > Same Shares.
To understand the Algebra here, the Sum of Initial Stock Prices is “fixed” as is the Sum of Price
Changes once you choose the initial stocks and have the price increases. But the New Portfolio Val-
ue depends on which stock goes up more. That is where the misunderstanding comes from, that the
Same Dollars is always better than the Same Shares. That is, a high priced stock can appreciate more
or less than a low priced stock. The initial value sum and the sum of price raises is the same no mat-
ter which stock goes up more, but the final value sum does depend on which stock goes up more.”
To sum it up, equal dollars is best when the lower priced stocks go up the most and equal shares is
best when higher priced stocks go up the most. Mark’s comments got me to thinking, and of course
that lead to firing up the computers to find out what approach really works the best.
My first test was to look at a ratio that we know selects good stocks, the five lowest price to sales
issues in the Dow. They were purchased in October and held for 9 months. The following table pres-
ents you with all the data, the year by year, blow by blow of this group’s return when viewed from
the equal dollar vs. equal share viewpoint.
5 Lowest Price to Sales - Return 9 Months Later

Return Equal $ Return Equal
Year Difference
Invested Shares Invested
1975 21.14% 20.11% 1.03%
1976 2.88% 1.64% 1.25%
1977 -14.20% -13.03% -1.18%
1978 -3.72% -4.73% 1.01%
1979 -0.37% -2.00% 1.63%
1980 -10.36% -18.09% 7.73%
1981 -10.35% -13.79% 3.44%
1982 49.37% 38.90% 10.47%
1983 -15.35% -21.33% 5.98%
1984 9.80% 5.87% 3.93%
1985 13.87% 12.82% 1.05%
1986 28.24% 28.03% 0.20%
1987 -8.71% -8.01% -0.71%
1988 4.51% -4.79% 9.29%
1989 -6.14% -5.28% -0.86%
1990 24.95% 23.86% 1.09%
1991 9.30% 8.12% 1.18%
Bonus Report | 17
1992 33.18% 28.18% 5.01%

1993 7.91% 5.30% 2.61%
1994 13.88% 14.00% -0.12%
1995 18.26% 17.35% 0.91%
1996 -6.28% -11.67% 5.38%
1997 19.47% 15.90% 3.57%
1998 21.18% 21.05% 0.13%
Year Difference
1999 6.63% 7.07% -0.44%
2000 0.91% -0.83% 1.73%
2001 -8.11% -2.27% -5.83%
2002 24.99% 15.65% 9.34%
2003 3.19% 2.34% 0.85%
2004 3.27% 0.79% 2.47%
Table 4a: Dow Equal Dollars vs Equal Shares 5 Lowest Price to Sales Raw Data

1975 -2004
Average 7.78% 5.37%
STD 0.1552 0.1487
Median 5.57% 3.82%
Max 49.37% 38.90%
Min -15.35% -21.33%
Table 4b: Dow Equal Dollars vs Equal Shares 5 Lowest Price to Sales Results
45% HIGHER RETURNS WITH EQUAL DOLLARS IN EACH STOCK

The difference is larger than I thought it would be. The average 9 month hold with equal shares was
5.37% while the equal dollars invested in each stock returned 7.78%. A return that is 45% better.
That 2.4% average gain per year is huge when considering a longer term compounding basis.
As one swallow does not a summer make, one test is suggestive but not an absolute. Knowing this I
tested the same buy and exit strategy as above but this time chose the five highest price to sales ratio
stocks in the Dow 30.
On balance these are loser stocks… despite the massive stock market gains from 1975, this group
lost -5.96% per year on an equal dollar investment in each stock and a staggering -9.2% per year on
an equal share basis.
Losers they are, and even more so if invested on an equal share not equal dollar amount.
5 Highest Price to Sales - Return 9 Months Later

Year Difference
1975 5.31% 6.53% -1.23%
1976 -22.56% -23.79% 1.23%
1977 3.46% 2.53% 0.93%
1978 -11.03% -25.37% 14.35%
1979 6.13% 8.19% -2.06%
1980 -23.64% -24.97% 1.33%
1981 -6.32% -7.80% 1.47%
1982 0.01% -4.70% 4.71%
1983 -12.33% -8.00% -4.33%
1984 12.77% 14.07% -1.30%
1985 33.82% 23.65% 10.17%
1986 -9.12% -5.80% -3.32%
1987 -25.05% -43.43% 18.38%
1988 -3.98% -2.17% -1.80%
1989 -13.76% -16.91% 3.14%
1990 26.11% 26.60% -0.48%
1991 -26.22% -34.44% 8.22%
1992 -3.52% -1.90% -1.62%
1993 -22.52% -22.96% 0.44%
1994 -6.57% -7.90% 1.33%
1995 7.60% 7.29% 0.31%
1996 -2.91% -9.61% 6.70%
1997 2.06% 2.07% -0.01%
1998 -12.25% -18.85% 6.60%
1999 -21.18% -24.61% 3.44%
2000 -5.35% -2.68% -2.67%
2001 10.29% 15.27% -4.98%
2002 11.45% 11.89% -0.43%
2003 0.81% -2.51% 3.32%
2004 -5.96% -9.21% 3.25%
Table 5a: Dow Equal Dollars vs Equal Shares 5 Highest Price to Sales Raw Data

1975 -2004
Average -3.81% -5.98%
STD 0.1456 0.1667
Median -4.66% -5.25%
Max 33.82% 26.60%
Min -26.22% -43.43%
Table 5b: Dow Equal Dollars vs Equal Shares 5 Highest Price to Sales Results
Bonus Report | 19
What this tells me is Mark’s math driven observations are correct and the data proves it. There is
another advantage of equal dollars. Since dividends account for much of the stock market gains, the
dividend return will be higher from equal dollars in low priced stocks than equal shares.
Now you know how to invest!
Bonus #7 Insider Buying
It’s hardly a new idea… even in the mid 1960’s folks like Perry Wysong and Wally Heiby were writ-
ing about buying stocks that had heavy insider (company officers for the most part) buying. Others
said the same thing about heavy insider selling. That is not as important. Why? Well an insider can
sell for any one of a hundred reasons; he’s buying a house, kids in college, someone’s sick, he/she is
getting divorced, a parent needs money, or there’s a large charitable contribution to be made.
When it comes to buying, however, there is only one reason to buy... you think you can make money
from the price rallying. The more insiders in a company that are buyers the better it is. The fact one
guy is bullish is not as impressive as the fact everyone in the company is a buzz with the prospects
and plunking down their bets.
To my knowledge no one has ever done a study on insider buying in just the Dow 30... so I thought it
was time we turn our attention to this data.
THE GOOD NEWS --- THE BAD NEWS
The good news is that insider buying really makes a difference... it is an excellent indicator of what
stocks to buy in the Dow. The bad news is that there is not a whole heck of a lot of insider buying in
this group. I’ll get to that issue in a moment. For now though, keep this in mind; buying and selling
all Dow 30 stocks in October and exiting on April 15th, from 1985 through 2003 would have shown
an average gain of 8.09%, with three years losing money. Holding until August first still nets us 3
losing years, but an average return of 18.302%.
Now let’s look at the results of buying the 5 stocks with the greatest insider buying in the Dow from
1985 through 2003 to see how those braced themselves against economic storms as well as their
return. The table below reflects the results of the October/April strategy when buying the 5 stocks in
the Dow that had the most insiders buying in the 6 months prior to October.
Statistics Insider Buying in Past 6 Months

Entry Date 6 Mth Return % 9 Mth Return %
10/28/1985 46.638% 33.631%
10/28/1986 31.274% 51.667%
10/28/1987 16.006% 14.023%
10/28/1988 14.034% 25.915%
10/28/1989 4.942% 16.017%
10/28/1990 38.86% 67.907%
10/28/1991 19.426% 20.719%
10/28/1992 4.601% 15.037%
10/28/1993 5.818% 11.087%
10/28/1994 14.932% 28.368%
10/28/1995 20.63% 17.196%
10/28/1996 16.845% 38.624%
10/28/1997 20.004% 16.694%
10/28/1998 22.194% 21.505%
10/28/1999 1.617% -4.179%
10/28/2000 18.665% 17.75%
10/28/2001 -1.893% -11.255%
10/28/2002 7.607% 21.462%
Avg Return 15.905% 21.1667%
Table 6: Exit April Following Year - 5 Dow Stocks Greatest Insider Trading
The differences are staggering… the 6 month buy of insider stocks does 2 times better than buying
all Dow 30! That’s a huge difference. Even going out for the 9 month hold the performance is bet-
ter than a buy and hold strategy, 18% vs. 21%. The number of losing years is also reduced in each
portfolio.
The next clip looks at a longer time frame of insider buying; here we look at the 5 companies that
showed the most buying in the prior 12 months. There does not seem to be much difference here
between the two sets of data. Both are clearly superior to being long the Dow itself… the problem
is there is not often enough insider buying to make a consistent strategy… but this is an important
tidbit of information to augment our selections.
Bonus Report | 21
Statistics Insider Buying in Past 6 Months

Entry Date 6 Mth Return % 9 Mth Return %
10/28/1985 46.638% 33.631%
10/28/1986 29.182% 49.806%
10/28/1987 16.006% 14.023%
10/28/1988 16.242% 25.567%
10/28/1989 4.942% 16.017%
10/28/1990 24.233% 34.329%
10/28/1991 21.84% 22.407%
10/28/1992 11.093% 21.697%
10/28/1993 5.818% 11.087%
10/28/1994 12.521% 26.326%
10/28/1995 23.83% 19.445%
10/28/1996 11.809% 32.477%
10/28/1997 17.173% 13.703%
10/28/1998 30.113% 28.246%
10/28/1999 1.617% -4.179%
10/28/2000 18.665% 17.75%
10/28/2001 -1.893% -11.255%
10/28/2002 8.229% 21.327%
Avg Return 15.687% 19.600%
Table 7: Exit April Following Year - 5 Dow Stocks Greatest Insider Trading
Frequently there is no, or precious little, insider buying in these stocks... it is not always possible to
find 5 stocks that reflect a lot of “smart money” infiltration. Hence, the data may not always be there
to “speak to us”, but when it is... we better listen up.
Bonus #8 Consumer Opinion Surveys
The all time best time to buy can be see in the following chart from the Federal Reserve.
The conditions that set up the incredible wealth making opportunities are:
1) We are in a recession
2) The Fed Consumer Opinion is 98 or lower
Chart 6: Fed Consumer Opinion
Bonus #9 One Indicator That Accounts for 50% of Annual Earn-

ings Changes
These markets are not easy to master. We know this from trading, but here’s a nice blurb from the
halls of academia, a paper, “Stock Returns, Aggregate Earnings Surprises, and Behavioral Finance”
S.P. Kothari MIT, Sloan School of Management Jonathan W. Lewellen MIT, Sloan School of Man-
agement; Jerold B. Warner Simon School, University of Rochester.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=380127
The authors present a good deal of research on the effect of earnings, and it may not quite be what
you expect.
“For example, over the last 30 years, stock prices increased 6.5% in quarters with negative earn-
ings growth and only 1.9% otherwise (significantly different with a Tstatistic of 2.6). In regressions,
concurrent earnings explain between 5% and 10% of the variation in quarterly returns, and between
10% and 20% of the variation in annual returns. The t-statistic on earnings is between –2.0 and –3.5
depending on how earnings are measured. These results provide strong, albeit indirect, evidence that
cash flows and discount rates move together.”
This seems odd… stock prices rally when earnings reports are bad? How can that be, it certainly
does not fit the conventional wisdom of earnings driving stock prices. Let’s look at this.
What Causes Earnings To Get Better???
Bonus Report | 23
We have always known interest rates and stocks move together, but what the impact is and why it is
may have been missed by some (like me). This paper takes the large bundle of economic data and
ties a string around all of it with this succinct comment:
“T bill rates alone explain more than 50% of annual earnings changes.”
Well that’s pretty clear. Earnings and rates are hand in glove, which leads to the crux of the dichoto-
my we have going here on bad earnings being good and vice versa. The authors also point out:
“We find a strong – economically and statistically – negative price reaction to aggregate earnings
news. This finding suggests that unexpectedly high earnings are associated with higher discount
rates, at least over the fairly short horizons we study... the results are also consistent with our argu-
ment that high earnings are associated with higher discount rates.”
A New Door Opens

What I think they have tumbled on here is that earnings increase the most lately in the interest rate
cycle (they did not directly address this issue). In short, as earnings get good, real good, our friends
at the Fed raise rates; hence if we look at the one dimension of aggregate earnings increase (which
should be bullish) we need to put that into the perspective of where rates are. This explains why poor
earnings reports appear to be bullish... poor earnings are often the precursor of drops in the discount
rate. Keeping in mind that T bills account for more than 50% of earning changes, it now makes sense
that bad earnings cause the Fed to lower rates which shortly causes stocks to rally.
My Point---the most fundamentally bullish positions in the market would be when there are
strong earnings increases with no possibility of the Fed hiking rates. The second most bullish
would be the turn around of the Fed lowering rates amidst a flock of poor earnings reports.
Bonus #10 High Levels of Unemployment are Bullish
This is the indicator you would prefer not to see. But, it’s track record speaks for itself. No good
thinking person likes to see others out of work. Yet high levels of unemployment tickles the hearts
and souls of investors. Perhaps it is the sad commentary of capitalism or, perhaps more realistically,
just a sign that things are so bad that they will soon get good again.
We can break this down further by looking at the annualized rates of return for the S&P 500
during various periods of unemployment. There are massive differences between high levels of
unemployment and future investment returns as you can see for yourself.
When unemployment is above 9%, the future is the brightest for investors. It also, in retrospect, is
also brightest for the unemployed because at that point unemployment rates are so high that they too,
just like stock prices, start to improve. So this is an indicator that’s good for the masses as well as the
1% or 2%.
Chart 7: S&P 500 Returns vs Unemployment
Bonus #11 The Politics of Deficits in the Stock Market

The Deceit of Large Deficits
Deficits are not what most people think they are. Let me explain it to you. The bottom line is deficits
means there is more cash in circulation if that’s true then more things will be purchased.
This means deficits add to the net disposable income of individuals, this added purchasing power,
when spent, provides markets for private production, inducing producers to invest in additional plant
capacity, which will form part of the real heritage left to the future.
Even the archconservative Cato Institute is on record as saying, “By almost any measure, America’s
economy has performed better in years in which the trade deficit rose compared to years in which it
shrank. During years of rising deficits, the growth of real gross domestic product averaged 3.2 per-
cent per year, compared to 2.3 percent during years of shrinking deficits.”
Bonus Report | 25
Chart 8: S&P 500 Returns vs Unemployment
Politicians of all stripes, from ultraliberal to ultraconservative will rail on and on about deficits. But
the unvarnished truth is that stock prices have always done better during periods of large deficits.
Yes, I know, someday there may be a day of reckoning… And then again there may not be since we
are living under a system of fiat money. The rules of a hard money, Gold backed, currency are very
different. Never, ever, fall prey to the idea that large deficits are negative for stock prices.
Bonus #12 The Federal Reserve Forecast of the Future
The Federal Reserve has laid out the future for the stock market. They did it without using any fancy
mathematical secret technical analytical tools… They simply looked up the progress of demographic
trends in America.
Imagine for a moment a society in which most everyone was in the age bracket of 18 to 25. They
would have some money, but not much. They would not be established yet. They would not have
much left over income to buy things from companies listed on the New York Stock Exchange.
That is what we call a negative population group for stock prices.
On the other hand if we had a tremendously wealthy group of people that had their debts paid for (or
substantially reduced) on their homes and cars, that disposable income would come into the market-
place. Its purchasing power would drive prices higher.
That’s what the following chart from the Federal Reserve represents, their forecast of stock prices…
P/E ratios… Into the distant future.
When people enter the 35 to 49 year old age bracket, they make more money than at any other time
of their lives. This chart shows us out into 2024 that the Fed is expecting low P/E ratios unlike the
high ones we saw in the late 1990s which, of course, would be conducive to stock market rallies.
It just gets down to this, peak earning years or peak spending years and spending drive stock prices
higher.
Chart 9: P/E Ratios
Wrap Up
Well, there you have it ball fans... in this course we’ve gone through market timing showing you
the actual long-term market cycles that are the most reliable. You have learned the best time to take
positions in the market and the best stocks to select when the time is right. You have the data. You
have the research, and you have seen the performance... now it’s time to go out and do it!
Doing it is the hard part. You will have fears and worries; not all of your positions will work out. You
will have losses but not nearly as many as you had before because now you have a consistent proven
method to stock market success which means for the first time in your life you can be a consistent
money maker. I wish you well.
You can now do what the average guy and what 80 percent of the mutual funds are not able to do...
you can beat the market! This is a staggering statement when you consider that 80 percent of the
funds cannot outperform the S&P 500 or the Dow Jones Industrial average. Funds don’t appear to be
Bonus Report | 27
such a great investment. Knowing that only 20 percent of fund managers can beat the market tells us
that we have a 20 percent chance of selecting the right fund. Eight times out of 10 the fund we select
will not do as well as just buying the Dow Jones Industrial Average. This is staggering.
By using some very simple rules we’re able to consistently outperform the Dow and in the process,
outperform the fund managers. We can do this without paying the fund managers their excessive
fees, without being exposed to a basket of stocks we know nothing about and to any possible chica-
nery on the part of wrongly intentioned fund managers. If the odds are 8 to 2 against us beating the
market through the mutual funds process, why not do it on our own?
There is only one reason... you haven’t known how... that is now a thing of the past. You can beat the
market averages, you can outperform the hot shots of Wall Street… go forth and prosper!
Larry Williams
2015
Acknowledgments
I’d like to thank several people for their contributions to this course and for increasing my under-
standing of investing and myself.
Voices From The Past: Edgar Lawrence Smith, George Seamans, and Henry Wheeler Chase
Friends: Gill Haller, Tom DeMark, Vic Niederhoffer, Yale Hirsch
My father, Dick Williams
My wife and trading partner, Louise Stapleton
A special thanks to my hero of a programmer, Hiroshi at Quantitative Analytics
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Larry Williams

Stock Trading and

The 10 Year Pattern in the United States Stock Market 6

Breaking it Down to Specifics… Taking it Year By Year 9

My Four Year Discovery 25

Dispelling Some Notions 36

The Best of the Best, 1900 to Date 39

Politics… A Special Consideration 39

P/E Formula for Predicted Future Returns 57

© 2015 Larry Williams CTI Publishing. All Rights Reserved.

The One Sure Thing of Stock Investing

Chart 2: Home Price Index

Yet, Market Timing is So Critical

The 10 Year Pattern in the United States Stock Market

“It’s about time.” My 1978 U.S. Senatorial Slogan!

Edgar Lawrence Smith: The All Time Market Genius

Chart 3: Dow Jones Industrial Average Decennial Pattern

Chart 4: Dow Jones Industrial Average Decennial Pattern

Chart 5: Decennial Pattern

Breaking it Down to Specifics… Taking it Year By Year

The Phenomenal “Five” Years

The Ten-Year Stock Market Cycle: Year in Decade

Chart 6: Dow Jones 1935

Chart 7: Dow Jones 1945

Chart 8: Dow Jones 1955

Chart 9: Dow Jones 1965

Chart 10: Dow Jones 1975

Chart 11: Dow Jones 1985

Chart 12: Dow Jones 1995

Chart 13: Dow Jones 2005

The “Sure Thing Seven” Years

Chart 15: Axe-Houghton Index of Stocks 1854 - 1902

Chart 16: Axe-Houghton Index of Stocks 1900 - 1935

Chart 17: 7th Year Pattern of Dow Jones Industrial Average

The Straight Eight Factor

Year March Price December Price % Gain

1878 3.24 3.45 6

1908 6.87 9.03 21

1918 7.28 7.90 9

1928 18.25 24.8 26

1938 10.31 12.69 23

1948 14.3 15.1 7

1958 42.11 53.49 27

1968 89.09 106.50 19

1978 88.82 96.11 8

1988 265.7 276.5 4

1998 1023.7 1190.0 16

2008 1316.94 877.56 -33

AVERAGE GAIN: 12%

My Four Year Discovery

So Easy a Kid Can Do it

The Meaning of 2002 - “142 Years of Market Success”

My Forecast of the Future

Long Term Cycles In A Nutshell

Years Ending In 5 Rallies All Year Long

Years Ending In 6 Buy Late In Year

Years Ending In 7 Late July Sell Off To A Buy