How I Use 10 Basic Rules to Time the Market, and Beat It

Dear Trader, My own favorites include the tried and true, "The trend is your friend," and "Buy low, sell high." The challenge, of course, is knowing which direction a stock is trending, and when a stock's price is low (or high). That's where Mike Turner fits in. He's the author of the best-selling book "10: The Essential Rules for Beating the Market," and he's also editor of Trade of the Week and a paid, weekly Mastering the Markets newsletter. Each week in Mastering the Markets, Mike uses his proprietary software systems along with a set of ten simple, easy-to-understand trading rules to identify sectors and individual stocks that appear to be in the early stages of a major move. What Mike doesn't use are opinions -- his own or anyone else's. By removing all emotion from the decision-making process, a la the fictional Spock of "Star Trek" lore, Mike's rules-based system takes the guesswork out of trading stocks. And it's a system that's been working well recently. Just last week, Mike and his subscribers locked in impressive short-term gains by selling their positions in ResMed Inc (NYSE: RMD), up +16.8% since Mike recommended it on Feb 9; Kinetic Concepts (NYSE: KCI), up +20.1% since Feb 1; Brookfield Properties (NYSE: BPO), up +26.5% since Jan 19, and Perrigo Company (Nasdaq: PRGO), up +30.0% since Feb 2. At the core of Mike's trading strategy are his 10 rules, which he summarizes thusly: Rule #1 -- Think Like a Fundamentalist. Growth is the key. When looking at a company's fundamentals, focus on earnings growth. Growth is what investors look for, growth is what drives demand for shares, and demand for shares is what drives prices higher. But be careful! You should never buy a stock based on fundamentals alone. Fundamentals only tell you what to consider buying. They do not tell you when to buy. Traders must use technical analysis to determine when to buy. (See rule #3 for further details on this.) Rule #2 -- Avoid Expensive Stocks. How much are you paying for each dollar in earnings? Use a stock's price-to-earnings ratio (P/E) to gauge how expensive a particular stock is. But remember: value does not move a stock's price higher. What value does is tell you whether you're getting a good deal on your purchase. In order to figure out whether you're getting a good deal, you should only compare a stock's P/E ratio to other stocks in its same industry. This is the best way to determine whether one stock is more expensive than another. Rule #3 -- Trade like a Technician. Use fundamentals to select which stocks to consider buying; use technical analysis to determine when the time is right to buy (and sell) those stocks. Technical analysts use stock charts and a variety of mathematical indicators to help them figure out when to buy. I pay particularly close attention to a stock's 10-week moving average. But the 10-week moving average I use is different from what most traders use because I shift it forward in time by three weeks. When a stock crosses this revised trendline

to the upside it gives me a much more reliable buy signal. And when it crosses this trendline to the downside it gives me a much more reliable sell signal. Most traders also are not successful because they don't pay attention to the charts for a stock's sector and industry. That's a huge mistake. I've discovered that half of a stock's price movement is tied to trends within its sector and industry. So it's critically important for you to know where that industry and sector are moving before you enter into any trade. Rule #4 -- Always Have an Exit Strategy in Mind. Why do you buy a stock? The primary reason to buy a stock is to sell it. Nobody has ever made a dime by buying the right stock at the right time. You only make money when you sell. And when it comes to selling, most investors don't have a plan in place. As a result, they will either get out too early, or more times than not they'll get out too late. The key is to know the right time to get out of a stock. I have developed a formula for doing just that. In each issue of Mastering the Markets, I provide a specific exit strategy (both a target price and a stop loss) for each and every one of my recommended trades. You should never buy another stock without first putting this type of exit strategy in place. Rule #5 -- Never Marry a Stock. Too many investors get into a stock because they love the company, or because the stock has made them a lot of money. In other words, they have an emotional attachment. They just can't bear to sell it, even if the price is dropping. Well, guess what? That stock doesn't love you back. It's just a piece of paper. Remember: the only reason to buy a stock is to sell it. Your decisions need to be guided by a strict set of trading rules, not by your emotions. Traders and investors who get emotionally attached to their holdings will suffer devastating losses time and time again. If this sounds all too familiar, then it's time to start following my ten rules. Rule #6 -- Watch for Insider Buying. Corporate insiders often sell their shares for many legitimate reasons. But they only buy new shares for one reason: the manager or executive knows or thinks something good is about to happen to the company. And these well-informed hunches are often correct. After all, nobody in the world knows a stock better than its top managers. Most traders ignore insider buying patterns. But I watch them like a hawk. I use my proprietary computer models to keep a close tab on insider trading patterns for over 6,000 different stocks. By doing so, I regularly identify a handful of stocks that are displaying significant recent insider buying. These stocks are much more likely to jump higher in the coming weeks and months. Rule #7 -- Institutional Ownership. When the "smart money" invests in a company, it's generally considered a good thing for share prices. However, you can have too much of a good thing. If 98% of a company's outstanding shares are owned by a few large institutions, then there are very few shares left to trade in the open market. And there's also more risk that the shares will plummet when those big institutions decide to sell. My "sweet spot" for institutional ownership is between 30%-60%. Avoid stocks with less than 5% institutional ownership or more than 95%. Rule #8 -- Diversification. Proper diversification will protect you from major losses and potential ruin. To keep the investing odds in your favor, never hold more than 30% of your portfolio in any one sector (such as biotech and drugs), and never hold more than 20% of your portfolio in any one industry (such as healthcare). Following this rule will force you to stay diversified and will reduce your risk. It will also give you exposure to sectors and industries that are trending higher at any given time. Even in bear markets there are always certain sectors and industries that are moving upward in price. Rule # 9 -- Asset Allocation. Most investors don't know how many stocks they should have in their portfolio, and they don't have a concrete strategy for how to spread their money across their positions. Rule #9 addresses this problem. When you're investing in the stock market, I believe you should invest your money evenly across all of your positions. For example, if you hold 20 stocks, then you should invest 5% of your money into each holding. I regularly give presentations in front of thousands of investors, and people often tell me that I should invest more of my money into my very best picks, and that I should invest less into stocks that aren't making me money. But I disagree. After all, why on earth would I ever invest a cent into stocks that don't have the potential to make me the most money? With this

invest a cent into stocks that don't have the potential to make me the most money? With this in mind, I only invest in my very best stock ideas. For you to do the same, you need to maintain a small portfolio of between roughly 10 and 20 positions. By keeping your portfolio small, you'll ensure that you're investing only in your very best ideas. And at the same time, by spreading your money evenly across a small basket of holdings, you'll stay diversified and you'll ensure that a sharp decline in one of your holdings doesn't drag down your entire portfolio. Rule #10 -- Timing the Market. There are ways to know, within a reasonably high degree of certainty, whether you should be in the market or out of the market. I have a chart I call the "CrossOver Oscillator," which analyzes the combination of new buy signals and new sell signals. When the lines cross in a certain fashion, I can tell you it's time to start thinking about taking profits off the table. That was the case in May of 2008, and we all know what happened after that. Even if my oscillator is early, you still have profits to take off the table, because inevitably the market has moved up strongly prior to the correction warning, and you've got a grand opportunity to put money in the bank. It is possible to exit near the top, and I can show you how. A key element is to have a set of rules that you follow. Don't let your emotions guide you. Don't guess about when to get into the market. Don't guess about when to get out. In the following interview with Bob Bogda, Mike expands upon his strict rules-based stockpicking process and reveals one of his current favorites...

Bob: How do you make your trading decisions? Mike: First and foremost, I follow my ten rules. Then I look at the top 20 or so stocks that my proprietary software systems identify, out of a universe of 6,000 stocks. I focus most of my attention on three things: a "fundamental score" that my proprietary computer systems assign to each stock, a similarly formulated "technical score," and a detailed analysis of each stock's industry and sector. My fundamental score, which is based on my ten rules and isn't available anywhere else, tells me at a glance how strong or how weak the stock is. My computer algorithms assign a score of 0 to 10 to each of several different analysis criteria for a stock's financial condition, including various growth rates and peer group comparisons. I do a similar type of scoring for technicals, including a score for whether the stock is trading above or below my proprietary trendline, a score for the "Zone" each stock is currently trading in (there are four Zones that range from the highest to the lowest price of the stock for the past three years), a score for the range of average trading volume, a score for the bullishness or bearishness of the stock's sector and industry, and a score for how long the stock has been in a "Buy Signal." Finally, we know that 50% of the movement in a stock is caused by movement in the stock's sector and industry, so my interpretation of these charts is influential in determining my final trading recommendations for my Mastering the Markets readers. Bob: How do you further narrow down the list of potential trades? Mike: Each week I develop an in-depth market forecast in order to develop a trading bias -bullish, bearish or neutral. Then I use a quantitative tool to find the highest-rated stocks and exchange-traded funds that fit my bias. If I'm bullish, I look for opportunities to buy. If I'm bearish, I look to take profits on my current holdings and sell stocks short into rallies. If I'm neutral, I look to take profits when possible and do as little trading as possible. Bob: What is your current market bias? Mike: I am generally bullish between now and mid-November, although I do expect to see a mild correction of 6% to 8% about mid-June. My longer-term forecast is definitely bearish, but that could easily change as time unfolds. I am very concerned about the huge U.S. debt load and the lack of real job growth. Bob: What are the strongest segments right now?

Bob: What are the strongest segments right now? Mike: Healthcare looks strong, especially health insurance. I also like some of the China stocks. Consumer cyclical stocks are showing strong upward technical trends. I like a number of technology stocks and even some of the transportation stocks, especially the ocean-going shippers. Bob: Out of these top segments, what is your favorite stock right now? Mike: China Automotive systems (Nasdaq: CAAS) is one of my favorites, particularly since it is a Chinese company. This automotive firm specializes in automobile and truck parts. China has become one of the world's largest automobile manufacturers and unlike in the United States, where for every car sold, there is just about the same number that are junked, in China the cars are rarely junked. Parts stay in demand for a long time and with the expanding middle class in China, this company could be a big winner for a long time.

Live long and prosper,

Bob Bogda Managing Editor Trade of the Week

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