Use Moving Averages to Spot Trend Changes

04/26/2012 7:00 am EST

Focus: STRATEGIES

Jim Rohrbach

President and Founder, Investment Models, Inc.

Veteran trader and newsletter editor Jim Rohrbach minces no words as he explains why fundamental and economic forecasts can lead investors astray—and why so few advisors use technicals. He explains how he uses some simple technical indicators to identify possible buy points in stocks.

Kate Stalter: Today I’m delighted to be speaking with someone who is a favorite of MoneyShow audiences, well known to many of you out there: James Rohrbach of Investment Models.

Jim, I thought maybe we could start out today with you telling us a little bit about your market timing methodology. Conventional wisdom has it that you can’t time the market, but as you and I have discussed, there are certainly ways to do it.

James Rohrbach: Well, that is an interesting subject in itself. I look at LinkedIn (LNKD) once in a while, and I see people who call themselves traders, and they have all kinds of ideas about how you have to look into the future in order to tell how to invest or trade.

Well, you can’t look into the future. If you can just identify when the trend changes, that’s all you need. Problem is, nobody knows how to do that.

I was invited to be a judge at a university here in Orlando, and we were judging four colleges of students who were in the finance end of study, and they had to come up with an analysis of a company, and then present it. I found it very interesting, and when they were speaking and I had a chance to interject, I asked the kids a couple of technical questions.

Afterwards, the professor came over to me. He said, “Mr. Rohrbach, they were asked to identify and analyze the company on a fundamental basis, not a technical basis.”

I said, “I’m sorry, I didn’t know that.” But he said, “It was good, because you sort of stopped them in their tracks and we could observe how they got around that.”

But then I started thinking: Now, these kids are in four different universities learning finance, investing, and nobody’s teaching them technical analysis. And I know why.

Kate Stalter: Why’s that?

James Rohrbach: Because they don’t know how to teach it, and therefore they couldn’t grade it. Isn’t that interesting?

So we’re getting a part of an education when we go to college and we major in finance. And technical analysis is sort of a mystery to most people. They all talk in terms to convince you that they know something about technical analysis, but they really don’t. They don’t know how to identify a change in the trend in the market, and it’s not that difficult, if you spend the time to try to figure it out.

I’ve been doing it for 40 years. I’ve identified every change in the trend in the market, and I know that’s not believable, because most people don’t want to believe it, because they’re being told constantly by brokers, etc., “Don’t try to time the market…it can’t be done.”

It can’t be done because they can’t do it.

Kate Stalter: Jim, let me follow up with what is the obvious question, based on what you’ve said: How are you identifying shifts in market trends?

James Rohrbach: Well, I developed many years ago—in 1964, I came up with this problem. I said to myself, “If I’m going to be successful, I’ve got to know when the trend changes.”

And I spent seven years working on the mathematics of that thing. I kept stumbling, but I finally came up with a way where I can take certain ingredients, which I’m not going to tell you what they are, and if I applied them to the mathematics, I could tell on a daily basis what the trend of the market was for that day.

In other words, I’d convert the action of the market into a number. That number represents the trend for today. If the market is going up several days in a row, that number will go up, and vice versa.

But you’ve got to know the ingredients, and you’ve got to use mathematics. Don’t listen to those guys on the Street, or wherever, who tell you the reasons for the market going up or down, because they have nothing to do with reality.

It’s all a mathematical thing for me, and mathematics are unemotional, and they don’t need to know what’s going on in Europe. Or what the president said today about student loans. Oh my, we’ve got a big problem there.

Continued…

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Kate Stalter: I’m going to attempt to drill down into some of these indicators a little bit, and I realize that you can’t reveal too much about your methodology. But there are some technical methods that do incorporate price and volume in their systems to identify shifts in market trends. Do you use price as well as volume?

James Rohrbach: Well, let me ask you this: Are they successful in identifying changes in the trend? If those are the ingredients that this person uses and it’s correct, it identifies change in the trend, there’s nothing wrong with it. But if it doesn’t, then you better keep searching.

You know, it’s not a difficult thing, especially with the technology that’s available today. When I started, there were no chart services, no computers, no information other than what you got in a newspaper. And today, oh my God, all the information that’s available!

For example, if you wanted to take something simple—and don’t tell anybody I told you this—do a crossover. You know what a crossover is, right?

Kate Stalter: Moving averages.

James Rohrbach: Yeah. Pick two moving averages. I like to use exponential averages, and plot them against your investment, whatever it is.

 I think Apple (AAPL) would be a good example. And everybody has a different risk level, risk tolerance, but if you use two numbers—people say use 50 and 100, or 50 and 200. Forget that. It’s too long; it takes too long to act.

How about 15 and 30? Or ten and 20? You could plug those into these programs today and do your own research. Take an Apple. I say take an Apple, because I get in and out, but there are some stocks like Apple that just keep going up.

And you’ve got to stay in there if you’re really going to capitalize on this thing. If you get out because Apple dropped ten points today, that might be a big mistake. And a ten and a 20, or a 15 and 30 exponential cross over will tell you: Stay in, stay in, stay in. Even if the market goes down 200 points.

That’s for an individual investment. I think it would work somewhat with the market itself. I don’t use it. I use it only as a backup, as a confirming indicator for my investments. I’m a professional trader and I do some things that I don’t recommend the average person do. Like shorting 2x the S&P 500.

When it starts down, or when somebody threatens to take away the credit rating of the United States. I said, “That doesn’t sound good to me. I’m shorting it.” Also, my timing indicator said it was a bad time for the market.

So, you know, everybody wants to be correct. Everybody wants to predict and everybody wants to convince me how smart they are. And when they start, I start losing interest.

You don’t have to be smart. You have to be intelligent. You have to have a strategy that tells you when to get in and out. Now I sell my strategy for $395 a year; about a dollar a day. And if you have that—and I’ve used it for 40 years—if you have something that’s worked for 40 years, then once you know where the market’s going, the trend of the market, then you can start playing around with individual investments. Whatever you like.

But don’t try to do it without it, and don’t try to guess that this market is going to correct. I believe it’s going to have a severe correction. I don’t know when, and I don’t care. In the meantime, if the market’s going up—even though I think there’s a big down move coming—I’m going to play the up move.

Just play it with the market. It’s telling you—and I know that’s kind of difficult for the average person to do, and it’s also very difficult for them to have the discipline to act on every signal. Your emotions get involved in this game, especially when your money’s involved.

And then you say, “I know the indicator says I should get out, but I’m going to stick around a while because I was listening to TV, and these guys say that this market is going to continue up for the next six months. Then in 2013, it’s going to take a big dive because of all the tax consequences.”

Well if you believe that, and you skip acting on an up market, you’re making a mistake. Just go with it as long as it lasts, and then when it turns down get out. Don’t ask why and don’t rationalize.

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