MTA Educational Foundation University Course – Technical Analysis of the Financial Markets ©2007 Lecture 11 - Technical Analysis and Portfolio Management This lecture series is produced by the Market Technicians Association Educational Foundation based on the detailed class notes of Charles D. Kirkpatrick II, CMT Copyright © All rights are reserved. 1 Successful Investors Need 3 Characteristics 1.Self knowledge 2.Market knowledge 3.Discipline to employ market knowledge

MTA Educational Foundation University Course – Technical Analysis of the Financial Markets ©2007 Lecture 11 - Technical Analysis and Portfolio Management This lecture series is produced by the Market Technicians Association Educational Foundation based on the detailed class notes of Charles D. Kirkpatrick II, CMT Copyright © All rights are reserved. 2 Portfolio Management Asset Allocation –How much in stocks Security Selection –What to buy –When to buy –When to sell Technical analysis is critical to answering “when?”

MTA Educational Foundation University Course – Technical Analysis of the Financial Markets ©2007 Lecture 11 - Technical Analysis and Portfolio Management This lecture series is produced by the Market Technicians Association Educational Foundation based on the detailed class notes of Charles D. Kirkpatrick II, CMT Copyright © All rights are reserved. 3 The Loser’s Game Example: Tennis is actually two games At the amateur level, players lose points –The victor gets a higher score because the other player makes more mistakes At the professional level, players win points –Ultimate outcome is determined by the actions of the winner Professional sports are a Winner’s Game, amateurs play a Loser’s Game

MTA Educational Foundation University Course – Technical Analysis of the Financial Markets ©2007 Lecture 11 - Technical Analysis and Portfolio Management This lecture series is produced by the Market Technicians Association Educational Foundation based on the detailed class notes of Charles D. Kirkpatrick II, CMT Copyright © All rights are reserved. 4 Portfolio Management is a Loser’s Game Passive indexes, the benchmark (or the other player in the game) have no costs –To win, investment managers must overcome the cost disadvantage Winning requires making fewer mistakes –Following defined sell disciplines prevents holding stocks falling to zero

MTA Educational Foundation University Course – Technical Analysis of the Financial Markets ©2007 Lecture 11 - Technical Analysis and Portfolio Management This lecture series is produced by the Market Technicians Association Educational Foundation based on the detailed class notes of Charles D. Kirkpatrick II, CMT Copyright © All rights are reserved. 5 “Almost all of the really big trouble that you’re going to experience in the next year is in your portfolio right now; if you could reduce some of these really big problems, you might come out the winner in the Loser’s Game.” - Charles D. Ellis Investment Policy - Why It Matters

MTA Educational Foundation University Course – Technical Analysis of the Financial Markets ©2007 Lecture 11 - Technical Analysis and Portfolio Management This lecture series is produced by the Market Technicians Association Educational Foundation based on the detailed class notes of Charles D. Kirkpatrick II, CMT Copyright © All rights are reserved. 6 Beating the Market Market Timing –Due to costs and risk of being out of the market, investment managers need to be right 75% of the time to break even Stock Selection –Efficient markets result from well-done analysis –Selecting tomorrow’s winners is a challenging task

MTA Educational Foundation University Course – Technical Analysis of the Financial Markets ©2007 Lecture 11 - Technical Analysis and Portfolio Management This lecture series is produced by the Market Technicians Association Educational Foundation based on the detailed class notes of Charles D. Kirkpatrick II, CMT Copyright © All rights are reserved. 7 Beating the Market (continued) Portfolio Strategy –Asset allocation or sector allocation can define success; challenges are similar to market timing Investment Philosophy –Develop a well-defined set of principles and strictly adhere to them

MTA Educational Foundation University Course – Technical Analysis of the Financial Markets ©2007 Lecture 11 - Technical Analysis and Portfolio Management This lecture series is produced by the Market Technicians Association Educational Foundation based on the detailed class notes of Charles D. Kirkpatrick II, CMT Copyright © All rights are reserved. 8 Invest Like the Best James O’Shaughnessy studied great investors and tested their ideas Successful portfolios had characteristics different than the overall market

MTA Educational Foundation University Course – Technical Analysis of the Financial Markets ©2007 Lecture 11 - Technical Analysis and Portfolio Management This lecture series is produced by the Market Technicians Association Educational Foundation based on the detailed class notes of Charles D. Kirkpatrick II, CMT Copyright © All rights are reserved. 9 Investing Styles Growth –Aggressive growth –Established growth –Momentum Value –Low price-to-earnings –Low price-to-sales –Low price-to-book –High yield 80% of a portfolio's return is attributable to style

MTA Educational Foundation University Course – Technical Analysis of the Financial Markets ©2007 Lecture 11 - Technical Analysis and Portfolio Management This lecture series is produced by the Market Technicians Association Educational Foundation based on the detailed class notes of Charles D. Kirkpatrick II, CMT Copyright © All rights are reserved. 10 Timing Styles come into and out of favor –1999 growth outperformed value –2003 value outperformed growth The best long-term managers stick with their style through various market cycles

MTA Educational Foundation University Course – Technical Analysis of the Financial Markets ©2007 Lecture 11 - Technical Analysis and Portfolio Management This lecture series is produced by the Market Technicians Association Educational Foundation based on the detailed class notes of Charles D. Kirkpatrick II, CMT Copyright © All rights are reserved. 11 Value Investing Combining value factors can be a winning strategy –For example, a low P/E by itself may lead to purchasing stocks heading into bankruptcy Best combination: –Low price-to-sales ratio –Earnings persistency (EPS up 5 years in a row) –Low price-to-book ratio –ROE > 15% –High share price relative strength

MTA Educational Foundation University Course – Technical Analysis of the Financial Markets ©2007 Lecture 11 - Technical Analysis and Portfolio Management This lecture series is produced by the Market Technicians Association Educational Foundation based on the detailed class notes of Charles D. Kirkpatrick II, CMT Copyright © All rights are reserved. 12 Stock Market Winners Biggest stock market winners share common characteristics: –Strong quarterly earnings acceleration –Identifiable group leadership –Important volume indicators –New leadership

MTA Educational Foundation University Course – Technical Analysis of the Financial Markets ©2007 Lecture 11 - Technical Analysis and Portfolio Management This lecture series is produced by the Market Technicians Association Educational Foundation based on the detailed class notes of Charles D. Kirkpatrick II, CMT Copyright © All rights are reserved. 13 Stock Market Winners (continued) Also, note the percentage increase in earnings per share was substantially more crucial than the P/E ratio as a cause of impressive stock performance –Look at the P/E at the pivot “buy point” and how as the advance continued, these stocks expanded their P/E’s

MTA Educational Foundation University Course – Technical Analysis of the Financial Markets ©2007 Lecture 11 - Technical Analysis and Portfolio Management This lecture series is produced by the Market Technicians Association Educational Foundation based on the detailed class notes of Charles D. Kirkpatrick II, CMT Copyright © All rights are reserved. 14 Growth Factors Twelve-month EPS change higher than average Last quarter EPS change higher than average Estimated EPS change higher than average Strong relative strength

MTA Educational Foundation University Course – Technical Analysis of the Financial Markets ©2007 Lecture 11 - Technical Analysis and Portfolio Management This lecture series is produced by the Market Technicians Association Educational Foundation based on the detailed class notes of Charles D. Kirkpatrick II, CMT Copyright © All rights are reserved. 15 C-A-N-S-L-I-M Popularized by William O’Neil Data readily available in Investor’s Business Daily Combines growth and value Based upon a study of past market winners

MTA Educational Foundation University Course – Technical Analysis of the Financial Markets ©2007 Lecture 11 - Technical Analysis and Portfolio Management This lecture series is produced by the Market Technicians Association Educational Foundation based on the detailed class notes of Charles D. Kirkpatrick II, CMT Copyright © All rights are reserved. 16 C = Current EPS growth – should be a minimum of 20% A = Annual EPS growth – should be at least 15-20% for 3 years N = New. The greatest winners had a major new product, new management, or new industry conditions A new high in price can alert you to new fundamental developments C-A-N-S-L-I-M

MTA Educational Foundation University Course – Technical Analysis of the Financial Markets ©2007 Lecture 11 - Technical Analysis and Portfolio Management This lecture series is produced by the Market Technicians Association Educational Foundation based on the detailed class notes of Charles D. Kirkpatrick II, CMT Copyright © All rights are reserved. 17 C-A-N-S-L-I-M S = Shares outstanding – past winners have had an average of less than 25 million L = Leadership – demonstrated by high relative strength for the stock and the stock’s industry group I = Institutional sponsorship – good stocks are owned by institutions M = Market – even good stocks go down in a bear market

MTA Educational Foundation University Course – Technical Analysis of the Financial Markets ©2007 Lecture 11 - Technical Analysis and Portfolio Management This lecture series is produced by the Market Technicians Association Educational Foundation based on the detailed class notes of Charles D. Kirkpatrick II, CMT Copyright © All rights are reserved. 18 C-A-N-S-L-I-M: When to Buy Buy on a breakout to a new high –Popularizes “cup and handle” formation –Confirmed by at least a 50% increase in volume Buy after the stock has formed a base –Minimum 7 weeks consolidation works best Buy within 5-10% of the breakout point Use an 8% stop loss

MTA Educational Foundation University Course – Technical Analysis of the Financial Markets ©2007 Lecture 11 - Technical Analysis and Portfolio Management This lecture series is produced by the Market Technicians Association Educational Foundation based on the detailed class notes of Charles D. Kirkpatrick II, CMT Copyright © All rights are reserved. 19 The Buy Decision High relative strength –Screens for stocks in the highest 10% –Calculated as (closing price/26-week moving average of price) High earnings per share growth rate –Screens for stock in the highest 10% –Calculated with quarters of the reported data to minimize seasonal influences (most recent 4 quarters/first 4 quarters)

MTA Educational Foundation University Course – Technical Analysis of the Financial Markets ©2007 Lecture 11 - Technical Analysis and Portfolio Management This lecture series is produced by the Market Technicians Association Educational Foundation based on the detailed class notes of Charles D. Kirkpatrick II, CMT Copyright © All rights are reserved. 20 The Buy Decision (continued) Low price-to-sales ratio –Screens for stocks in lowest 30% –Calculated as: (Price)/(Last 4 quarters of sales)

MTA Educational Foundation University Course – Technical Analysis of the Financial Markets ©2007 Lecture 11 - Technical Analysis and Portfolio Management This lecture series is produced by the Market Technicians Association Educational Foundation based on the detailed class notes of Charles D. Kirkpatrick II, CMT Copyright © All rights are reserved. 21 The Sell Decision Hold until –Relative strength declines below the 30th percentile or –Earnings per share growth rate declines below the 50th percentile

MTA Educational Foundation University Course – Technical Analysis of the Financial Markets ©2007 Lecture 11 - Technical Analysis and Portfolio Management This lecture series is produced by the Market Technicians Association Educational Foundation based on the detailed class notes of Charles D. Kirkpatrick II, CMT Copyright © All rights are reserved. 22 The Results

MTA Educational Foundation University Course – Technical Analysis of the Financial Markets ©2007 Lecture 11 - Technical Analysis and Portfolio Management This lecture series is produced by the Market Technicians Association Educational Foundation based on the detailed class notes of Charles D. Kirkpatrick II, CMT Copyright © All rights are reserved. 23 Conclusion Portfolio management requires buy and sell rules Technical analysis adds value to this process

MTA Educational Foundation University Course – Technical Analysis of the Financial Markets ©2007 Lecture 11 - Technical Analysis and Portfolio Management This lecture series is produced by the Market Technicians Association Educational Foundation based on the detailed class notes of Charles D. Kirkpatrick II, CMT Copyright © All rights are reserved. 24 Putting It All Together Stock Selection: A test of relative stock values reported over 17-1/2 years* –by Charles D. Kirkpatrick II, CMT –2001 Dow Award Winning Paper –Provides results of real-time tracking of two portfolio management models –Portfolio usually holds stocks *Paper available for download on