August 25th, 2025: Capital Preservation Rule Protecting Gains While Waiting for the Perfect Market Entry

AT THE BEGINNING OF THIS WEEK:

The market opened this week a little to the downside. The only value of the opening is it sets one datapoint for us. Other than that, nothing the market does matters to us until this Friday.

I have wrestled for years as to how much of our internal machinations we use for making trading decisions to share with you. Most of our clients (individuals and institutions) don't really care how the sausage is made. They just want us to produce great returns at the lowest risk possible. On the other hand, I believe it is helpful if you understand some of the 'why' we make the trade decisions that we make. There is logic and significant analysis that goes into these decisions and I suspect that at least 'some' of you would like to understand more how the sausage is made...

To understand more about what we do, you first need to know what we believe:

We believe in several foundationally sound principles of the stock market, including:

1. It is impossible to accurately and consistently predict what the market, an individual stock, an industry, a sector, or any component of the stock market is going to do in the future with regard to moving higher in price or lower in price, and

2. While moment-to-moment swings in the market can occur, the larger the group of equities being monitored, the slower various "trends" of that group tends to change from being a positive trend to a negative trend, and

3. Generating unrealized gains is hard, but protecting hard-earned unrealized gains is critically important, and

4. The best laid plans of mice and men often go awry, so this means a Plan B has to always be in place when the market, for whatever reason or no reason at all, defies all expected analysis and goes against you.

Armed with the above foundationally sound principles of the stock market, here is the process we go through to tell us when to get into the market, how to get into the market and when to get out of the market...

1. Knowing that all bull and bear markets can be technically identified, historically (looking backward in time), we have identified the single moving average that has been able to accurately identify bull and bear market cycles within the first two weeks of the beginning and end of each cycle and be correct over 92% of the time. We call this our "Bull/Bear Trend". It tells us when a new trend has (most likely) begun and when that trend has (most likely) ended, and be right 92% of the time. Having a 92% probability that we know if the US stock market is in a bull or bear trend, is an important element of trade decision-making. Keep in mind that just because we can be in a bull market, as we are right now, it does not mean that a devastatingly strong whipsaws that cannot occur, and punish investors severely. Knowing the market's current trend is important, but that alone is not sufficient for deciding when to be in or out of the market.

2. Mathematical analysis of moving averages tells us that trends change direction rather slowly. This movement is measured in terms of momentum, buying/selling pressure generated by traders (buyers/sellers) and market volatility (how stable the market is at any one time). Each of these elements are scored for support, or lack-thereof, of how, when and what to trade.

3. Lastly, and most importantly, there are times when the data and the application of our analysis rules of that data, indicates we should definitely stay in a trade with one critically important exception... risk of losing unrealized gain. This analysis is not predicated on trends, momentum, buying/selling pressure or market volatility. This analysis is done from the perspective of financial pain. When a trade has gone well and our client accounts are experiencing strong growth due to increasing equity market prices, the goal of protecting that gain becomes more important than 'proving' we are in the right trend at the right time. We call this our "Capital Preservation Rule". When this rule is activated, it ignores all other technical and mathematical assessments of the stock market and simply looks at how much pain (emotional stress and fear that clients have when seeing recent gains in their portfolios simply evaporate because of a sudden reversal in the stock market). We have put a mathematical rule in place to deal with this situation, and it is this: As soon as a trade has achieved at least a 10% growth in unrealized profit, we monitor the weekly movement in that unrealized profit. If that profit drops by 10% or more, we exit the trade and turn 90% of the unrealized gain into realized profit. Keeping in mind that sudden reversals in the market can exceed that 10% threshold, it still sets an objective to preserve capital over and above proving that we are still in a bull or bear trend.

What all of the above means is this... We have 3 Strategies: 1x Strategy, 2x Strategy and 3x Strategy. When in a trade, the 2x will move up or down twice as much as the 1x; the 3x will move up or down three times as much as the 1x (approximately, of course). But, once the 1x has generated 10% in unrealized gains, the 2x will have generated 20% in unrealized gains, and the 3x will have generated 30% in unrealized gains (again... approximately). But all 3 will have the same Capital Preservation Rule of exiting the trade with the goal of protecting 90% of that unrealized gain. That means the 1x would (as a goal) exit if the 10% gain moves down 1%, preserving 90% of that 10% unrealized gain. The 2x would have the goal of preserving 90% of its unrealized gain, preserving a profit of 18%; and the 3x would have the goal of preserving 90% of its unrealized gain, generating a realized profit of 27%.

In effect, this means that all three Strategies would have the same percent exit rule and this means our 3x clients get the 3x upside and, in effect, 1x downside; keeping in mind that 10% of the 3x unrealized gain is a far bigger number than 10% of the 1x unrealized gain.

I don't know of any financial services firm or money manager that uses a rule identical to our "Capital Preservation Rule". Yes, there are many firms that use a "trailing stop loss" based on total portfolio value, but that is not the same thing at all.

Our goal is to grow your capital using smart, inciteful technical algorithms to know when to get into the market, how to get into the market and when to get out of the market, while never losing site of the potential risk in play at all times.

I hope the above helps you understand a little more about how the sausage is made. And for those of you with money either still sitting on the sidelines or with any other firm that has that money invested in the market in any kind of buy-and-hold strategy... you really need to get that money set up with us while we wait for the next entry point. Just reply to this email and we'll get in touch with you to discuss next steps.

At this writing, we have 5 major triggers that must all be in agreement before we can get back into the market. 3 are in agreement and 2 are not. Friday will tell us if all 5 are in agreement. What are those 5 triggers? I'll hold that explanation until next week.

THE NOISE:

Alex Goodwin, Vice President

The indexes were mixed last week after investors weathered a couple of volatile trading sessions. The S&P 500 tallied 5 negative days in a row, while the Nasdaq 100 put together a 6-day losing streak of its own, however, both indexes made a sizeable rally on Friday to cut their weekly losses significantly.

Before Friday’s Jackson Hole speech, traders weren’t sure whether Fed Chair Jerome Powell would stay hawkish or hint at easing. Inflation signals were mixed, but trending in the right direction, but it appeared that investors were weary of what Ja Po could bring to the table. On Friday, Powell hinted that there was a high likelihood that the Fed would be cutting interest rates come the September meeting and the CME Fed Watch probabilities concur, showing an 84% chance of a .25% rate cut for the September 17th meeting.

We know that the market always reflects 100% of all the known information available, and of course this includes the likely upcoming rate cut. However, markets tend to behave in a certain way before any major monetary policy decisions. Historically, when the Fed signals that the economy is slowing but not in crisis, stocks tend to perform well before and just after the first rate cut. Lower rates mean cheaper borrowing and higher present value for future earnings, especially for growth stocks. The most recent example of rate cuts (outside of the Covid crisis cuts) was in 2019 when the Fed cut a total of .75 basis points in 3 months, during this time the market rose roughly 12%. While the situations are certainly not identical to one another, it will be interesting to see how much the market has already priced in.

Interestingly, investor sentiment became more cautious as the week progressed, before rebounding. Surveys showed a notable rise in bearish sentiment among individual investors through mid-August. In fact, bullish sentiment declined nearly 10 percentage points over the past month, while bearish sentiment jumped to approximately 45% (from 33% a few weeks prior). So, while it appears investors and economic reports are both mixed on their market sentiment, we will continue to evaluate the data and let our rules govern our market decisions.

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