What Happens After the Market Goes Down?

. September 23, 2011

When the stock market has upward momentum, it tends to keep going up. However, downward momentum, like we've had since August, tends to be followed by sideways movement with high volatility, as this post from the MarketSci blog shows. 

It's better to be in Treasury bills than in the market when there's negative momentum. This is both for the lower volatility and to earn interest.

For small investors, this could mean moving to a money market fund until the stock market starts going up again. 

To learn more about momentum, start here.

Great Reads: Should You Buy When the Market's Up or When It's Down?

. September 18, 2011

Trading and Investing

Should you buy when the market's up or when it's down? (CXO Advisory)
A two-year mean reversion effect. (CXO Advisory)
More on mean reversion. (Mebane Faber)

Option selling doubles volatility-adjusted returns. (Mebane Faber)

Do financial firms sell to your rationality or your psychology? (CXO Advisory)

Strategies that short battle the rest of the financial universe. (Slope of Hope)

Old methods of diversification are becoming less effective. (Reformed Broker)
On performance chasing. (Reformed Broker)
The market is becoming more volatile. (Reformed Broker)

The Greek one-year yield was triple digits last week. (Zero Hedge)

Free finance and commodity widgets to put on your Web site. (Oil Price)


On effective promotional marketing. (Internet Marketing Fire)

Twenty-five quotes from Margaret Thatcher. (ListVerse)

"The best writing advice I've ever received." (Donald Miller)

Affordable Living

"How can I afford to stay home with my baby?" (Baby Center)

How to shop for your own health care. (CNBC)

The student loan bubble, illustrated. (Reformed Broker)

Edmond, OK tops CNBC's "Best Suburbs" list. (Edmond Sun)

Walking with God

Dealing with the death of a parent. (Fabs Harford)
Tired of being 'gospel-ed'. (Fabs Harford)


A postman's revenge. (YouTube)

Abstruse Goose: Get it?

Book Review: The Total Money Makeover

. September 17, 2011

In this book, Dave Ramsey lays out a brilliant plan for getting out of debt.  It's brilliant because any rational human being would see it as sub-optimal, but Ramsey realizes something important about human nature. We're not rational.

A rational plan for paying down debt would be to tackle the highest-interest debt first, keeping only what you need for one month in a savings account. An emergency fund would make little sense, as you could borrow from credit cards for that purpose.

Ramsey, on the other hand, realizes that most of us don't have the discipline to follow that plan. If we did, we wouldn't be heavily indebted in the first place. A cash emergency fund meets our psychological desire for security. Paying down the smallest loan first, regardless of interest rate, gives us the chemical rush that comes from successfully getting rid of the first loan payment.

Total commitment to the plan is necessary to override our cultural desire to keep up with the Joneses. The Joneses borrow to maintain their lifestyle. Getting rid of debt requires that we do the opposite. The key phrase in the book is, "If you will learn to live like no one else [frugally], later you can live like no one else [wealthily]."


My one quibble with the book, and it's a major one, is his investing methodology. Ramsey claims that you can make a 12% annual return by buying and holding mutual funds with the best long-term track records. He recommends this asset allocation (p. 157, 2007 edition):

25% Large cap stocks
25% Mid cap stocks
25% International stocks
25% Small cap/emerging market stocks
It's not the 12% that I disagree with. There are simple trading methodologies, such as momentum, that achieve compound annual returns in that neighborhood with low volatility. A market with a high return (momentum) over the past 12 months tends to produce a high return in the following 12 months.

The kicker is that the momentum effect disappears if you look back more than a year. Markets that had strong returns two years ago tend to underperform going forward. This is called mean reversion.

What if a large-cap manager got his track record by investing in a sector that happened to outperform large-cap stocks in general? If that sector mean-reverts, his outperformance will turn into underperformance. Think about home prices, which moved steadily upward from World War II until 2005. Those who bought real estate based on that track record suffered large losses from 2006 to 2009.

If a fund manager uses trading strategies, mean reversion might not apply. Strategies like value (buying "cheap") and momentum (following trends) don't disappear permanently the way the railroad, utility, and communications booms did. But these strategies aren't part of Ramsey's asset allocation.

A long-term track record is only an asset if you have a good reason to think that the manager's outperformance will continue.

Recommended, with Caveats

If you're in debt right now, Ramsey's approach is psychologically tailored to get you financially free. I recommend the book for that purpose. Borrow it for free at the public library.

Once you're out of debt, you can use the income that used to go to debt payments toward self-funding a ministry dream. For this, Mebane Faber's book on momentum investing, The Ivy Portfolio, is a good read. I've also written a post on how momentum works. 

I'll leave you with some excerpts from Dave Ramsey's book The Total Money Makeover:

Having been a millionaire and gone broke, I dug my way out by making a decision about looking good versus being good. Looking good is when your broke friends are impressed by what you drive, and being good is having more money than they have.

Are you starting to realize that The Total Money makeover is also in your heart? You have to reach the point that what people think is not your primary motivator. Reaching the goal is the motivator. Do you remember the circus game where you swing the large hammer over your head to hit the hit the lever to send a weight up to a pole to ring the bell? You reach the point that you want to ring the bell! Who cares if you are a ninety-eight pound weaking with gawky form? The girls are still impressed when the bell is rung. When the goal, not how you look, begins to matter, you are on your way to a Total Money Makeover. (p. 33, 2007 edition)
 Here's a quote from the inside jacket:
Instead of promising the normal dose of quick fixes, Ramsey offers a bold, no-nonsense approach to money matters, providing not only the how-to but also a grounded and uplifting hope for getting out of debt and achieving total financial health.

Ramsey debunks the many myths of money (exposing the dangers of cash advance, rent-to-own, debt consolidation) and attacks the illusions and downright deceptions of the American dream, which encourages nothing but overspending and massive amounts of debt. "Don't even consider keeping up with the Joneses," Ramsey declares in his typically candid style. "They're broke!"

He gives sure-fire ways to build up savings for emergency funds, for your kids' college, and for your retirement, and he supplements this wisdom with heartfelt stories from real people just like you - people who were once languishing in debt but are now flexing their strong fiscal physique.

The Total Money Makeover is all about "renewing your mind," using God's ways of handling money (over 800 scriptures deal with money) to be "transformed" (made over). It's a plan to stop being "conformed" to the ways of the world and as ridiculously broke as the rest of our culture.

And this isn't theory. It works every single time. It works because it is simple. It works because it gets to the heart of the money problems: you.

Book Review: How to Retire Overseas


How to Retire Overseas is the best book I've seen on making a permanent move to outside the United States. It lists fourteen countries where it's possible to have a comfortable, safe middle-class life for less money than in the U.S.

The book rates each country on cost of living, cost of housing, climate, health care, infrastructure, accessibility to the U.S., language, culture/recreation/entertainment, taxes, special benefits for foreign retirees, and education/schools.

The author, who has lived and raised children abroad for twenty-five years, gives specific advice for people in various life situations. She provides details about buying health insurance, which areas are suitable for raising and schooling children, and three countries where it's possible to retire without paying local taxes.

My favorite chapters are the ones about settling in and overcoming challenges and cultural differences. Despite its high cost of living, the United States is still best place for Americans to fit in and get work done. Overseas, it can be a hassle to do simple things like open a bank account, navigate city streets, and make utility payments. Most places don't have the combination of work ethic, infrastructure, and freedom to do business that we have. Despite this book's title and aim, I've become more convinced that there's no place like home.

If you've always wanted to be a missionary but haven't been able to raise the funding, one possible path is to self-fund. For this purpose, I highly recommend reading How to Retire Overseas.

I'll leave you with an excerpt from the inside jacket:

Imagine yourself at home- on the front steps leading to a sandy white Caribbean beach, sitting atop a balcony overlooking the streets in a bustling Latin American city, or inside a hillside villa in Europe- the retirement of your dreams. With a dash of adventure and an ounce of planning, you can turn your fantasies into reality- on any budget, without increasing your bills or sacrificing your lifestyle.

In this definitive guide, author Kathleen Peddicord uses over twenty-five years of experience to show anyone how to retire overseas, with or without retirement income. By providing critical questions for readers to answer, Peddicord helps determine where your ideal overseas home is located. Once you know where you're headed, she outlines how to handle the move itself, and guides you through the process of establishing yourself in a foreign country, including how to:

*Find and rent or own a home
*Research and understand your tax liability
*Establish secure bank accounts
*Obtain health insurance and medical care
*Make friends in your new home
*Avoid common pitfalls and mistakes

With advice from the author's own experience living abroad as well as personal stories from the hundreds of retirees she's helped achieve their retirement goals, this essential guide helps anyone plan for and enjoy a new life overseas- for less money than a traditional retirement in the United States.

How to Trade Like Zorro

. September 11, 2011

Have you heard this song? "Billy, don't be a hero; don't be a fool with your life."

Tom Sosnoff quotes this song to describe traders who put on too much risk and lose everything when the market goes the wrong way. But is there a Christian heroism that involves taking smart risks?

Simmering ideas about heroism came together for me yesterday while I was watching The Mask of Zorro.

Let me list some of the myths about heroism first:

  • "Heroes take control of their environments."
  • "They bend others to their will."
  • "They never run from a fight."
  • "They take insane risks and glory in it."
Keep these myths in mind as you watch this fight scene from the movie:

Do you see the contrast between Zorro and the myths described above?
  • Zorro doesn't brutally take control of his environment. He doesn't force others to obey. Instead, he sets up situations where people play into his hands. He anticipates what they're going to do and makes plans that seem risky but actually have a high probability of success. "[Captain Love] will come into your circle soon enough. You need not chase him."

  • Zorro is not afraid to run from a fight. He always engages others on his own terms. Sometimes this means running, sometimes it means letting others attack, and sometimes it involves laying traps. He hides in the shadows and shows himself when he's ready. He breaks his attackers apart into small groups and tackles those groups one at a time.

  • Zorro takes smart, well-planned risks. His goal in this particular battle is to strike fear in the hearts of his enemies. He takes the necessary risks necessary without going overboard. He escapes while he's ahead.
Live to Fight Another Day

As a one-man show, Zorro absolutely cannot afford to get crippled. Everything depends on his staying alive. This is a lot like trading. If you depend on trading as an insurance policy or the means to fund a ministry dream, you can't afford large losses.

My own trading strategy allows for a lot of unexpected problems. I know that eventually I'll be wrong, face bear markets, deal with high volatility, and encounter market crashes. I get to pick and choose the right trades for each set of market conditions. I can't control the market, but I can choose trades on my own terms.

There's also a time to run away in trading. When the favorable conditions for a trade go away, I close the trade out, sometimes at a loss. This is preferable to taking the risk of larger losses with no statistical profit advantage to justify that risk. The most important thing is to live to fight again tomorrow.

Don't Be a Hero

People tell me all the time that trading is too risky. But I see those same people spending all of their liquid capital putting 20% down or less on a house. That, to me, is risky: if the house goes down in value or the owners can't make their payments, the owners lose all of their money. They may even end up in foreclosure and then bankruptcy. How will they support their children then?

When the movie ends, there's only one Zorro. If he dies, there won't be a sequel. No one will get the girl. Would Zorro take the kinds of risks that most homeowners do?

Zorro as a Type of Christ

If the idea of Zorro as a trader isn't bizarre enough, imagine Zorro as a representation of Christ.
  • Jesus had the power to take control of His environment, but He took on flesh and came into a sin-corrupted world as a helpless baby.

  • He didn't force others to obey but made His points through intelligent arguments and Scripture. Depraved human beings hated Him for it.

  • Jesus engaged others on His own terms. He answered questions with more questions or complete silence. He told parables instead of explaining things directly. After a while, no one dared to ask Him any more questions.

  • Jesus didn't feel obligated to fight. He slipped away from crowds and sometimes refused to do what people requested. He knew when people were trying to trap Him and only allowed it to happen on His own terms: at the cross.
A better understanding of Christian heroism and the nature of Christ will make us better traders. There's a lot at stake. Dream big, take smart risks - and get the girl.

Great Reads: Sir Isaac Newton as a trend-follower?


Trading and Investing

What if Sir Isaac Newton had been a trend-follower? (Mebane Faber)
Missing the "ten best days" isn't such a bad thing. (Mebane Faber)

September is a weak month for the stock market. (Surly Trader)
Positive feedback loops and market crashes. (Surly Trader)

What happens to bond prices as interest rates change? (Mebane Faber)

Stock market valuation models: P/E ratios. (Mebane Faber)
"Cheap" is not always cheap. Huh? (Reformed Broker)

Recession odds at 50%? (Reformed Broker)

Which countries will dominate the global economy in 2030? (Economist)
Economic indicators color-coded on a world map. (TradingEconomics)

What are options good for? (Condor Options)
The spread between volatility indices has interesting information. (Option Pit)

How good is published academic research? (Marginal Revolution)


Who lost work during the Great Recession? (New York Times)

How do you successfully market to your best customers? (Seth Godin)
Expensive advice isn't necessarily better. (Seth Godin)
Is your work environment still organized using a factory model? (Seth Godin)

Comparison of video hosting services. (Wikipedia)

Watch out for conflicts of interest. (Dilbert)
Watch not just what you say, but how you say it. (Dilbert)
On making decisions without thinking. (Dilbert)
Did you mean that? (Dilbert)
Creativity? (Dibert)


Cornelius Van Til: downloadable audio and courses. (Gospel Coalition)

Marriage and Family

One hundred must-see movies for men. (Art of Manliness)

What would happen if you let your defenses down? (Boundless Line)


We're still figuring out how to send files to people. (xkcd)

xkcd: Are interest rates low enough for you yet?

Life as Mission


In America, leisure is treated almost as if it's a human right. We grow up in a youth subculture which feeds and celebrates distinctly childish interests. Remember this "Toys 'R Us" commercial from the 1980's?

Then we have eight-hour work days, mandatory breaks, weekends and some three-day weekends, vacation, and even a retirement that's supposed to be funded by the government.

The printing press,
an early robo-slave
This is the result of increased productivity. Each generation has an increasingly efficient set of robo-slaves that does our laundry, waters our lawns, and even deposits our paychecks for us. There are robo-slaves at work that make copies, ding our co-workers' phones with text messages, and do complex analytical work. As computers become more capable, we don't have to work as hard.
With all this leisure time, why aren't we happier?

Part of the reason is that we are built for mission. God gave Adam work to do. Unproductive leisure is not the kind of joy-filled work Adam did before the Fall.

I suggest three ways to bring mission back into the work you do.
  1. Redeem the work you're already doing. What can you do to love God and love your neighbor in the responsibilities you've already been given? Can you be an agent of change in your workplace's culture?

  2. Replace some leisure time with short-term mission. You don't have to go overseas to do this. If you're going to take a three-day weekend anyway, is there something your family can do that would be both enjoyable and Gospel-centered? Helping others might bring your family more happiness and fulfillment than a weekend lounging around playing video games.

  3. Cultivate long-term mission-oriented goals. Again, this can integrate into your existing plans. Are you saving for retirement anyway? Can some of those funds be used to make your retirement a period of service and not just leisure? Are you saving and investing enough to have a reasonable chance of getting there?
I'll leave you with a few quotes from Fabs Harford's read-worthy blog post, Why Am I Weary?
Maybe the reason we’re weary is not because we’re pouring our lives out for others, but because we aren’t.

Life can feel like a chore if we aren’t on mission....

Want to be refreshed?  Want to be like a watered garden?  Want to be satisfied and guided continually?  Care about people.  Pour yourself out for them...

What if God ordained mission for us; to provide energy and joy; and what if satan has kept us from that great stream of grace by convincing us that mission is a threat to our energy and joy?

Or, maybe there’s another way Satan could sabotage the design of mission.  There are no shortage of us who are pouring ourselves out without the promised result in Isaiah because when we do engage in mission, we act as if we’re doing God a favor.

Life feels like a chore because we serve out of duty and not delight.
 Read her full post here.

On Being Wrong


Admitting we're wrong takes character. It means denying our own supposed omniscience and sovereignty. We live in a world which is uncertain and seems to make a habit of pointing out our mistakes.

Trading is one of those areas where our unwillingness to be wrong costs money. Do you remember when the S&P downgraded the U.S. credit rating in August? Nearly everyone I knew, including I, was saying that this downgrade would inevitably lead to higher long-term interest rates and that it was a great time to short bonds. As it turns out, the opposite happened. Long-term interest rates are lower today than they were in August.

We're Limited

Because we're human beings and not God, we have only a limited ability to take in and process information. As a result, we tend to think that whatever information we have is a comprehensive picture of the world, when in fact other things we haven't considered may be more important.

Why did interest rates go down in August? In retrospect, maybe the Euro zone crisis or the possibility of a recession in the emerging markets caused capital to flee to U.S. Treasuries, causing interest rates to fall despite the credit downgrade. It takes character to admit that we don't really know.

Follow Momentum

Using momentum as a market timing tool helps us admit when we're wrong. We buy in when upward momentum appears and sell when that momentum goes away. We admit that whatever our opinions about the world are, the potential cost of being wrong is far higher than the potential cost of selling too early. People who bought stocks in 2001 and early 2008 because the market was "cheap" and "couldn't go down any further" paid the price in a big way.

Because admitting that we're wrong requires humility, following a trading plan based on momentum takes character. We have to be willing to let mathematically calculated trading signals override our own opinions.

For more about momentum trading, start here.

Take a look at the TED talk below for more about the importance of understanding our fallibility.

Most of us will do anything to avoid being wrong. But what if we're wrong about that? "Wrongologist" Kathryn Schulz makes a compelling case for not just admitting but embracing our fallibility.

Great Reads: People Listen to Stories, Not Facts

. September 4, 2011


People listen to stories, not facts. (Seth Godin)
Two earthquake-related thoughts about crowd behavior. (Seth Godin)
You can either seek to get more out of an opportunity or less. (Seth Godin)

Will tomorrow's business stars come from agriculture? (Reformed Broker)

Keep shortcuts to commonly used Web pages on your desktop. (Ask Leo)

If you could have any super-power, what would it be? (Reformed Broker)

How to handle excellent and/or devastating news. (This Is Indexed)

In the information age, information is no longer precious. (Seth Godin)
Is the Internet empowering or censoring citizens? (YouTube)

Trading and Investing

All strategies, including buy and hold, involve forecasting. (Strom Macro)
Teachers of "buy and hold" may have a conflict of interest. (Reformed Broker)

An interesting take on momentum investing metrics. (Vector Grader)

Hedge funds have delivered positive alpha since 1995. (Institutional Investor)

Marriage and Family

Divorce rates: things can be more complicated than they seem. (Boundless Line)


Which way is the market going? (Abstruse Goose)

Depth perception. (xkcd)
"I'm sorry." (xkcd)

Things that make your skin crawl. (This Is Indexed)

Logic. (Dilbert)


Schools kill creativity.