Manual & Description of Service

Kirkpatrick & Company, Inc.

Kirkpatrick’s Market Strategist

Description of Service Purpose of Service The Market Strategist subscription service is a quarterly and weekly technical report that provides market timing and stock selection based on a long series of studies by Charles D. Kirkpatrick II, CMT.1 The reports provide investment managers with timing signals for market trends from which they can formulate their long-term investment strategy and short-term trading tactics. The reports also offer stock selection using relative price strength analysis, one of the only methods to statistically refute both the random walk and efficient markets hypotheses in Figure 1 – Performance of Bargain List, Bargain Portfolio (Bargain List adjusted for market timing), S&P 500, and Value Line Geometric (December 29, 2006 – January 26, 2018)

1

Kirkpatrick, Charles D. and Julie R. Dahlquist. Technical Analysis: The Complete Resource for Financial Market Technicians, 3rd ed., New York, NY: Pearson Education as FT Press. 2015

www.charleskirkpatrick.com

Kirkpatrick & Company, Inc. stock prices. The reports fully disclose the techniques, formulas, variables, and value included in the timing and selection models. A rigorous walk-forward optimizing analysis determines the proper future parameters.

Format Weekly: Called the “Weekly Market Strategist”, this report is sent to subscribers over the weekend using daily market price data to time trends in the U.S stock market, the U.S. long-term bond market, gold, crude oil, emerging foreign stock markets (an ETF), and the Bitcoin market.

It also includes the Bargain List of stocks that have met prescribed relative strength purchase requirements, and a list of additions and deletions to and from the list for that week. The list includes a column for ranks in relative price strength, relative earnings-growth and price-to-sales; date and price when added to the list, profit or loss, and a suggested protective stop level based on volatility. The Bargain ETF List shows the same information as the Bargain List but includes only ETFs and ETNs. The report also includes updated intermediate-term charts showing market-timing signals. For the stock charts, there is a legend that describes the abbreviated symbols as well as a listing of the specific Bargain List rules.

Quarterly: Called the “Quarterly Overview”, this report of 9 to 12 pages is sent quarterly on a regular basis and covers the timing of the intermediate- and long-term trends in the U.S. stock market, U.S bond market, gold, crude oil, industrial raw materials, agricultural product prices, foreign stock markets in aggregate, the Japanese stock market and the U.S. Dollar. It additionally includes the timing results of three economic models that were the subject of the studies reported in my book2 and states the annual performance of the Bargain List over the past three years.

Investment Philosophy Any and all investment methods focus on the highest gains with minimum risk. Risk, unlike conventional thought, is defined in my lexicon as the possibility of losing money, not of losing less money. Some managers equate gain and risk with performing better than an index or competition. This concept means that in a market decline, a portfolio’s performance relates to how little it loses money relative to its competition. In my mind, this idea is ridiculous. Portfolio management is a business that should be striving to profit at all times when the market is favorable and to sit out those times when the odds of losing are high.

Disputing the standard concept of using diversification as a means of decreasing risk in stock portfolios, I believe that to reduce risk encompasses two principle concepts: market timing and relative strength stock selection. We know and have seen examples in the recent primary stock-market advances that stock price performance is uncorrelated. In other words, each stock travels in a different direction from another, up or down. All stocks don’t participate in the rise, and that is the reason for using “relative strength” as a selection criterion. During a stock market 2

Kirkpatrick, Charles D. Time the Markets: Using Technical Analysis to Interpret Economic Data, New York, NY: Pearson Education as FT Press. 2012

www.charleskirkpatrick.com

Kirkpatrick & Company, Inc. advance, you want to be fully invested in the most robust stocks, regardless of their concentration in industry or theme. In significant stock market declines, however, stock prices become strongly correlated. They tend to all fall together, even foreign stock markets. For this reason, the ability to time the markets for significant declines is crucial for profiting in the stock market.

During a stock market decline, you want to be in cash or cash equivalents.

Market-timing is a controversial subject, rejected by many investment professionals for its lack of preciseness. This argument is silly. When has any investment decision been precise?

Some managers argue that it is impossible to time the market for advances and declines and that the market always goes up eventually. They forget about the 39% decline between 2000 and 2002, and the six years and nine months it took to return to the 2000 peak or the 54% decline between October 2007 and March 2009 that took five years and five months to recover to its previous peak. The entire decade was spent attempting to catch up what the money lost in those two declines. Most managers who survived through the downturns and recoveries had peer pressure not to try timing. The wishes of the customers reinforced that opinion, the majority of whom were on the wrong side of the market, buying at the peaks and selling during the subsequent rallies. To time the markets, one has to divorce himself from the “buy and hold” types who either never lived through a sharp decline or were unconscious when one occurred.

Investment Method Market Timing The two methods I employ for market timing are the filtered, dual, moving-average, crossover systems, and derivations of Wilder’s DMI (Directional Movement Index).3 I develop all systems through experimentation, optimization testing, and walk-forward analysis.

Dual, filtered, moving-average, crossover system: Regarding a portfolio (not individual issues which sell stops can protect from capital loss.) the best method of reducing systemic risk is the use of market timing. Market timing is a method of determining when the overall stock market is headed downward or upward. It is a concept believed by many to be impossible to accomplish. I vehemently differ. I have found, without becoming intensely mathematical, two simple methods that have worked for me: (1) simple moving averages (SMA) and (2) Wilder’s DMI. I have experimented with various combinations of moving averages and have found that a dual, filtered, moving-average, crossover system is the best use of moving averages. “Dual” means that because market tops and bottoms have different configurations, I've found that a separate crossover system for each outperforms other standard methods. “Filtered” means that each signal price must reach a predetermined distance beyond its occurrence before registering as an active signal. If it doesn’t pass the filter, the system abandons the signal and waits for another. This procedure lowers the number of whipsaws often seen with moving average crossovers. Finally, because no system is perfect, each position must be protected by stop orders to minimize capital risk even further. The timing signals reduce risk and increase the likelihood of continuous

3

Wilder, J. Welles, Jr. New Concepts in Technical Trading Systems. Greensboro, SC: Trend Research, 1978.

www.charleskirkpatrick.com

Kirkpatrick & Company, Inc. profit, and the stops add additional safety. The specific parameters for the crossover systems, where used, are described in the Quarterly Overview.

Figure 2 is a chart of the signals generated by the dual, moving-average system. The system is longer-term and suffers from almost no whipsaws. A graph showing the moving averages is occasionally shown in the weekly letter and always in the Quarterly Overview.

Figure 2 – Dual, filtered, moving-average, crossover signals of S&P 500 (weekly: March 2007 through January 2018)

DMI Timing System: Trading encompasses both long and short positions over short periods, usually just days or weeks. Alternate directional indications come from the behavior of the DMI (see Indicators below) and also are protected by a volatility-adjusted, protective stop exit. I code the rules in TradeStation, then optimize walk-forward a series of trials, sometimes in the millions, and determine the final parameters for each market. I disclose these parameters on the charts in the publications, and subscribers can request the software programs.

The DMI produces two figures each day representing the buying pressure(blue line) and selling pressure(red line) that day. I use these results along with filters and stops to develop a model based on the spread between them. I plot the results of the optimization and walk-forward analysis on the charts and include the parameters for each market. The system takes the distance between the two lines when it reaches a maximum. The maximums occur at or near a turning www.charleskirkpatrick.com

Kirkpatrick & Company, Inc. point in the price. A price top happens when the buying pressure peaks and the selling pressure bottoms, and vice-versa at price valleys when the selling pressure is higher than the buying pressure. When a maximum spread contracts by a certain optimal percentage, a price peak or trough has occurred, and the model waits for the price to continue beyond its price filter limit when an action signal occurs. The parameters needed for the model are run through a walk forward analysis to gauge if they will work with future prices.

Figure 3 – Short-term DMI trading signals on Dow Jones Industrial (daily: May 2, 2016 to February 1, 2018)

In addition to the buy and sell signals, the model calculates the ATR (a volatility measure described in Indicators below) for each bar, smooths it with a moving average, and signals when the price has moved opposite from its current trend by some multiple of the ATR. This calculation gives us an exit stop for the existing position based on the volatility of the stock or index.

The parameters for all the values required to run the model have again been tested and subjected to walk forward analysis.

www.charleskirkpatrick.com

Kirkpatrick & Company, Inc.

Figure 4 – Long-term DMI trading signals on Dow Jones Industrial (monthly: August 1988 to February 2018) Figures 3 and 4 show how the DMI method gives appropriate signals. Figure 3 is a daily bar chart of the Dow Jones Industrial Average for the period May 2016 to February 2018 with the many signals that occurred. I use this short-term series for swing trading direction. When I use monthly bar charts of the Dow Jones Industrial in Figure 4, the signals become less frequent but just as important. It is these signals that determine when the Bargain portfolios goes in and out of cash.

Stock Selection Once we resolve the market direction favorably, we can then invest in stocks. Relative price strength is the basis for the selection of individual issues. Relative strength has been rigorously studied in academia4 and elsewhere5 and is widely accepted by those who have investigated it as the best means of selecting stocks. Different calculations of relative strength have been proposed and proven useful, but I believe the Levy6 method using a ratio of the closing price to a simple moving average of the price is the best. It is the basis for my studies and calculations and is one of the subjects of my book on investment strategy.7 (Performance of this selection method for more than ten years appears in the weekly report, (Figure 1 is an example).

Jegadeesh, Narisimhan, and Sheridan Titman. “Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency,” Journal of Finance 48 (1993): 65-91. and ibid. “Profitability of Momentum Strategies: An Evaluation of Alternative Explanations,” Journal of Finance 56 (2001): 699-720.

5 O’Shaughnessy, James P. What Works on Wall Street. New York, NY: McGraw-Hill, 1997 6 Levy, Robert A. “Relative Strength as a Criterion for Investment Selection.” Journal of Finance 22, no. 4 (1967): 595-610.

7 Kirkpatrick, Charles D. Kirkpatrick’s Investment and Trading Strategies: Tools and Techniques for Profitable Trend Following. New York, NY: Pearson Education as FT Press. 2014 4

www.charleskirkpatrick.com

Kirkpatrick & Company, Inc. The principal selection criterion in my system is the relative price strength ratio. Other screens having to do with a price-to-sales or earnings growth have appeared at times, but neither is as profitable as using relative price strength. The stocks selected by this method are reported weekly in the Bargain list (Blue line in Figure 1) in the Market Strategist letter. Other vendors also calculate the proper ratios, the most reliable being HGSI, a web-based data provider that can you with a free trial at www.highgrowthstock.com.

A good sell system will protect investments from individual stock losses by selling them from a portfolio when they fall behind the general market. Unfortunately, most investment advisors have no standard for selling stocks when they begin to falter. Indeed, many advisors will buy more shares of a declining stock, believing that the stock is even more attractive. Nothing could be more dangerous. Test after test has shown that a declining stock price has a strong tendency to continue downward. Because the risk of capital loss is so crucial to successful investing, I have always been amazed that professional management pays so little attention to it.

One of the advantages of using relative price strength is that we also have reliable and tested signals of when to sell a particular issue.

Selection Criteria The universe of stocks used to find new additions to the Bargain List begins with all NYSE, AMEX, and NASDAQ listed issues. The total list varies in number but includes about 8,500 items each week. After discarding penny stocks and very lightly traded ones, and filtering out each issue with a price below $5 or a 50-day moving average of dollar-volume below $50,000,000, the final investment universe becomes about 4,500 stocks from which to choose.

I use two kinds of relative-strength methods to find new names for the Bargain List.

Both ways use a ratio of the weekly close price to a moving average of past weekly prices. First, where available, I calculate the relative strength ratio of closing price to its 30-week simple moving average for every stock in the universe of 4,500. The computer then sorts the list by the ratio from high to low and ranks each stock by percentile. 99 is the strongest, 0 is the weakest. I consider only those stocks with a percentile of 97 or better for inclusion in the Bargain List.

The second relative strength method uses a similar ratio but doesn’t rank the results and is called the “Absolute� technique. It looks only for those stocks with ratios above a predetermined threshold gained from the experiment. Currently, the ratio is the closing price to its 61week moving average, and the buy threshold is 1.47. Thus any stock with both a ratio above 1.47 using this method and a relative rank in the first technique of 97 or better is likely to be included in the list. On the sell side, I have found that a relative position below percentile 58 on the strength scale, or 1.04 in the absolute method, is the statistically best time to eliminate a stock from the list using relative strength.

Bargain List The Bargain List is the list of those stocks that meet the current ownership criteria. I delete stocks from the list if either of the relative ranks or ratios decline below the thresholds

www.charleskirkpatrick.com

Kirkpatrick & Company, Inc. above. I also remove them if their closing price breaks below an ATR stop level reported in each Bargain List weekly report.

I calculate each week two sets of the performance data. They are graphed as shown in Figure 1 and appear in all monthly and weekly publications. One is the performance of the Bargain List itself without market timing. The second list is called the “Bargain Portfolio” and is the Bargain List adjusted for market timing. When the market direction is bearish, as determined either by the moving-average system or the DMI system, the Bargain Portfolio liquidates all holdings and awaits a positive turn in the timing system. Because moving averages lag behind prices, the timing system is always late at tops and bottoms. When the two timing methods turn positive, the Bargain Portfolio begins reinvesting in the stocks available in the Bargain List. The Bargain List is calculated each week regardless of the market position.

Indicators Used in Commentary Average True Range (ATR) For stops either long or short, I use the ATR as a measure of volatility and calculate the proper level for the stop based on it. This method is called the “Chandelier stop” for what reason I don’t know. The procedure is to calculate the ATR for the stock and multiply it by a parameter derived through experimentation. The parameters (period of ATR and multiplier) for a long-stop are different than for short-stop. The long-stop is used when the position is long and subtracted from the highest high since the position entry. The sell order is entered every day because the high might change and most certainly the ATR will change. A short position is handled just oppositely from the long-stop order and is placed above the lowest low since the short position entry.

The reason for using a volatility-adjusted stop is that the other methods have problems.

For example, a percentage stop is a fixed parameter and cannot adjust for changes in volatility. It only adjusts for price. I suppose the filters I apply to entries suffer from the same fault and perhaps someday I will experiment with volatility-adjusted filters, but for now they introduce too many variables and make the model too complicated.

The Standard Range calculation used on bar and candlestick charts is the difference between the high and low of that bar. An average range, therefore, is average of those standard ranges over a predefined period. This average is often used as a measure of volatility.

The Welles Wilder range is called the “True Range” and uses the high, low, and previous close of the last two bars.

www.charleskirkpatrick.com

Kirkpatrick & Company, Inc. • •

Standard Price Range = High – Low Wilder Price Range = the largest of o Today’s high to low o Today’s high to yesterday’s close o Today’s low to yesterday’s close The graphic in Figure 6 is Wilder’s drawing of the average true-range calculation.

Figure 6 – Diagram of Wilder True-Range.

Source: Wilder, J. Welles. New Concepts in Technical Trading Systems. Greensboro, SC: Trend Research, 1978.)

The Average True Range (ATR) is an unusual method of averaging concocted by Wilder. As an example, a 14-bar Wilder average true range takes yesterday’s ATR multiplied by 13 + today’s TR, and the whole result then divided by 14.

ATR = [(N-1)*ATR-1 + TR] / N where N is the period.

This measure of price range calculates pure price volatility that is missed in the standard method, especially in 24-hour markets, because it accounts for all trading activity over a continuous time rather than that included only in active trading. It is similar to an exponential moving average because it doesn’t suffer the drop-off effect that occurs in a simple moving average. It is used in the calculation of Wilder indicators such as the DMI, ADX & RSI and as a filter for protective stops.

Directional Movement Indicator(DMI) As defined by Wilder, directional movement is a measure of trend strength taking into consideration the net of upward and downward trading pressure. It is calculated as follows: 1) The 2nd bar value is the absolute amount by which the 2nd bar trading range exceeds the 1st bar range, and is explicitly measured as whichever is larger of: 2) The 2nd bar high to the 1st bar high (+DM) or 3) The 2nd bar low to the 1st bar low (-DM).

4) In an “outside” bar, for example, the larger of the two outside ranges is the directional movement, and in an “inside” bar, no figure is used. www.charleskirkpatrick.com

Kirkpatrick & Company, Inc. 5) All DM’s are positive numbers.

You then pick a period over which the movement is to be measured. The standard is 14 bars but can be any length, usually determined through optimization. The Positive Directional Indicator and Negative Directional Indicator are calculated by averaging, using Wilder’s method, +DMs and –DMs over the past period and dividing each by the ATR over the same period. For 14 bars, the formula would look like: 14-bar Positive Directional Indicator (+DI14) = +DM14 / ATR14 14-bar Negative Directional Indicator (-DI14) = -DM14 / ATR14

Figure 7 – Directional Movement of 1000-tick bars showing +DI in blue and –DI in red (S&P Emini futures (ES): January 22, 2016) Notice in Figure 7 that the DI’s often cross each other and give signals as to the next trend direction. The crossovers are usually late, depending on the length of the DI moving averages, but they are similar to any moving average crossover and are useful for signaling long-term trend beginnings. The earlier “whipsaws” have to be filtered out using price filters.

www.charleskirkpatrick.com

Kirkpatrick & Company, Inc.

Subscription Information Cost: $195/year.

Delivery: Email notice that letter is on a specific website address – currently use ISSUU.com – from which the issue can be read, downloaded, and then printed.

Ordering: 1. Mail check to Kirkpatrick & Company, Inc., 1 Bowen Road, Kittery, ME, 03904-1355.

2. Go to website: www.charleskirkpatrick.com and click on “Market Strategist” tab at the top of the page. On “Market Strategist” page click on the yellow button at lower right marked “BUY NOW.” This action will send you to PayPal where you can either use PayPal or a private credit card. Just follow the instructions.

Tutorial Information Cost: $2,000/day Delivery: Visit southern Maine or New Hampshire for a personal, one-on-one instruction session. Mr. Kirkpatrick meets with you here in Kittery ME/Portsmouth NH for an entire day and an introductory dinner the evening before the session. The choice of technical subjects is entirely up to you. Cost of transportation and meals (other than the evening before) are not included. $1,000 non-refundable deposit required on sign up.

Ordering: 1. Mail check to Kirkpatrick & Company, Inc., 1 Bowen Road, Kittery, ME, 03904-1355.

Options: • Mr. Kirkpatrick travels to your location (you pay for the cost of Mr. Kirkpatrick’s transportation, overnight, and meals).

• Additional session attendees are allowed up to ten at $1000/person.

Questions, Comments, Suggestions or Complaints: email: kirkco@capecod.net www.charleskirkpatrick.com