What does Methodology mean?
When it comes to the Patterson Relative Strength, methodology means how we differentiate between stocks we like and stocks we are not interested in. There is a method to the madness. By design, our method points us to the the strongest stocks our there and the system does a lot of heavy lifting for us. Oops, there's that tricky word, system.
Methodology really means system. The Patterson Relative Strength Report is essentially a system for picking when to buy and sell which stocks. That is a good thing and a bad thing. It is good because being a system means we can duplicate the process over and over and over with little effort. And, because we can replicate it, we can establish expectations for results in varying market conditions going forward. The bad news is that any system can go bad. They can work for a while and then seemingly never work again. I guess you could call it the dark side of system based trading. We have a very good system. That much we know. So, the natural question becomes, what are the odds of the system going bad on us?
Can the PRS System go bad?
Glad you asked. That's the great thing about writing a two sided conversation by yourself, you always get the questions you want.
Moving right along... The effectiveness of the PRS system is directly tied to the overall condition of the market. In other words, when the market is in a major bear market, the PRS system, which is a long only system, is going to suffer with the market. In a Bull Market, the PRS System is going to out perform the market. Its that simple.
In a bear market, almost all stocks go down. If you own stocks during a bear market, it doesn't matter how great they are, a lot of them are going to go down. The good news is we have the PRS Time Plane to help us adjust our level of market exposure.
Out side of a bear market, the PRS system is as rock solid as they come, and I have tremendous confidence in this point. So much so that I put my name in the title.
First a little background on trading systems. Give me a system, any system, I don't care how good it is. I am pretty sure I can break it. Would you like to know how you go about breaking what appears to be a good system right now? Simple, throw more data at it. No Problem you say....OK, throw random data at it, lots of it.
I have become so ruthless when it comes to testing a system that I have a program that will select a stock at random from how ever many you will let it choose from. Then it picks a date from however much data you have, and then it forces the stock through the system. The results are often surprisingly bad. What worked in 1999 didn't work too well in 2000, and what worked in 2002 didn't work to well in 2003. But, what worked in 1998 did work in 2003, but I didn't know that until 2004. The point is if you are going to use a systematic methodology you put it through not just an acid test. I am talking the Sulfuric Acid Test. The approach needs to work across an extremely broad spectrum of stocks and time frames.
How does the PRS methodology handle the acid test?
OK, How's this for an acid test. I used historical data from 1996 through the end of 2006, over eleven years total. I included all stocks on which historical data currently exits. I used the Worden Telechart Gold database as of February 2, 2007 as the historical data set. The PRS databased has been built over the past five years using Worden Telechart data.
In short, I ran the whole market through the PRS system. The results are plotted below
From January 1996 through February 2007 the S&P 500 advanced about 135%. The blue line on the chart shows the performance of the PRS Open Active Positions over the 11 year period with an advance of over 1,350%. There are pullbacks along the steady march higher, and returns were flat during the great bear market from 2000 to 2002. There is no denying the PRS system has a vulnerability and that vulnerability is a big giant bear market. Outside of that, the PRS system produces consistent winning trades.
The chart above tells us that we should stick to investing and or trading stocks on the PRS Open Active Position table. If we do that, at a minimum, we are starting with a small group of stocks that are most likely to outperform the market. Following the PRS methodology stacks the odds of success in your favor.
OK, PRS is all about Relative Strength. What makes your Relative Strength approach work?
Relative Strength, stick with the top stocks and you can expect top notch performance. The PRS system ranks about 6500 stocks. If you take only the top 10% (stocks with a 12-month PRS of 90 or higher) that is 650 stocks. Which one are you going to buy? Picking something out of 650 is better than picking something out of 6,500, but it is still a mess. This is why we track both six-month and three-month PRS rankings.
We start by looking at the 12-month PRS rankings and thin things down from there using the shorter-term rankings. For a stock to have a high 12-month PRS ranking, it has to be doing something right, but from a timing stand point, simply having a high 12-month PRS ranking is not enough. That is why we also have 6-month and 3-month PRS rankings. These shorter-term metrics provide us with tremendous detail regarding the stocks popularity cycle. This gives us a major advantage with our entry points.
Our approach works because we begin by looking at only the strongest stocks on a 12-month basis. We then use the three and six month rankings to single out stocks that are ripe for a well timed entry point. One benefit of our approach is our entry points are rarely time sensitive. Unlike some popular methods, you don't have to watch the market every day waiting for a stock to reach a certain trigger price at which to buy. A major problem with "price specific" entry triggers is that often a lot of people will be watching the exact same price point. If you are first in line that is great, but more often than not, the end result is everyone ends up paying a higher than desired price and that cuts into returns. Our approach does not suffer from this problem.
A stocks is either in our buy zone or it is not. One it has reached the buy zone, delaying the purchase date by one to five days, in the grand scheme of things it makes very difference. Once a stock comes into our buy zone we have time to evaluate the stock. We have time to determine if it really is a good company with a bright future.
We start with strong stocks and by design, our entry signals are well timed. This results in a list of very strong stocks, and then from that list only the very best stocks to go into our model portfolios.
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