The discount advantage: compounding safe profits

For people interested in how to produce consistent, safe profits, what issue is the simplest to explain and demonstrate? Perhaps it is the issue of only buying markets that are the most discounted.

Sample investment results (shown below):

Using cash trading of stocks: two double digit gains and two single digit gains (total profit of over 30% in 3 months)

Using leveraged trading of ETFs (over 100% profit from the same opportunities in the same 3 months)

Using select insurance policies (several hundred percent gains from the same opportunities in the same 3 months)

What is “discounting?”

People are familiar with the term “discounted,” as in “disregarded” or “dismissed as not being worth much.” In a retail business, discounting simply means reducing the price of something temporarily. When discounting an item, reducing the price (to a discounted sale price) does not lower the quality of the discount items. The discounts are just temporarily cheaper, right?

For investors, the target is buying things at a lower price than they can be sold in the near future. Temporary discounts are absolutely ideal.

There can be a few methods to measure which markets are most discounted (and how much they are discounted). In the example below, for simplicity, I review a single method of measuring discounting.

Again, my interest here is just to briefly present a few simple examples of the advantage of investing in discounts. By measuring how discounted a market is, we get objective data about the future profit potential of that market as well as an indication of how much risk there is of further discounting.

When a market is currently being discounted (disregarded) by 50% of interested investors, then there are still a lot of investors that could further discount that market (as in withdraw from buying and shift toward selling). The more enthusiasm there is for a particular market, the more risk there is of a decrease in enthusiasm.

However, if a market has already been discounted by more than 90% of the investors who are interested in that market, then there are a lot investors who may change their sentiment and begin to buy in to that market (which drives up prices). The more that a market is already discounted, then the less is the risk of further discounting. When a market is most discounted, that tends to be the time with the most potential for the prices in that market to rise far and fast, plus with the highest probability.

The data showing the logic of only buying discounts:

In summary, I used a quick glance across 12 markets to identify the most favorable sentiment levels. I selected the only two markets that both had periods of extreme discounting (twice for each market, for a total of 4 excellent discounts). 

Next, I show the prices for those two markets across 3 months. I highlight the best times to buy those two markets within those 3 months. Finally, I show that the correlation between the periods of extreme discounting and the most profitable times to buy that market.

The charts:

12 bp charts colored

Above are 12 “sentiment” charts to measure which markets (groups of similar stocks) are most discounted. This was for a 12 month period.

Note that I have no interest in the specific companies or even in the various stock sectors. I simply quickly sorting to identify sentiment extremes. For reference, sentiment fluctuations are shown for 11 groups of stocks in the US, plus sentiment for Canada’s stock market (the Toronto Stock Exchange/TSEX).

Note that in green I highlighted the only two charts that went to single digit “sentiment ratings.” Two other charts got down to “almost interesting levels” (below 30… highlighted in orange).

The other 8 markets had sentiment levels that are “far above extreme discounting.” 3 of them had sentiment above 50% for the entire 12 months. Those are the markets that are “least discounted.” That indicates a long period of high risk for sudden, sharp, lasting declines in price (eventually). The other 5 market had sentiment above 50% for the vast majority of the 12 months and sentiment levels never fell far below 50% (elevated risk with no significant discounting).

The above screenshot was obtained from the following link, which you can click to see updated data (for current sentiment levels): http://stockcharts.com/freecharts/candleglance.html?$BPENER,$BPGDM,$BPFINA,$BPTRAN,$BPNDX,$BPSPX,$BPINDU,$BPINFO,$BPMATE,$BPTSE,$BPHEAL,$BPSTAP|D|0

Here the sentiment lows can be identified and then used to test for a correspondence to rising prices:

sentiment

Do you see the red line and the blue line each have two “lows?”

sentiment4
What happens to prices when discounting is at extreme levels?

Here is the price data:

2 price charts

Can you see when would have been the best times to purchase those markets for a quick profit?

2 price charts w green

Notice the green highlights above of lows (circled) that were followed by sharp and persisting increases in price.

2 price charts w green+

In addition to the sudden gains from those circled lows, there are often price rallies lasting several weeks afterwards.

Now, let’s combine the price data with the sentiment data to assess whether the times of extreme discounting were the best times to buy:

combined

That is the chart without any notations. In the chart, I show that the two lows in the green sentiment line correspond to the two lows  in the red price line. Also, the two lows in the pink sentiment line correspond to the two lows in the blue price lines.

combined1

In other words, the best times to buy those markets were when enthusiasm for those markets was lowest (the most discounting).

combined2

How big were the gains (across 3 months of time but only a few weeks of actual trading)?

Using cash trading of stocks (available in most brokerage accounts): two double digit gains and two single digit gains (total profit of over 30% in 2 months)

Using leveraged trading of ETFs (available in many IRAs even without any new permission forms): over 60% profit from the same opportunities in the same 2 months

Using the buying and selling of select insurance policies (accessible through most IRAs after signing one extra permission form):gains of hundreds of percent from the same opportunities in the same 2 months

When using an investing method that is extremely reliable, it may be interesting to consider a few ways of profiting from those opportunities. First, the three periods of discounting could each be traded for quick gains of close to 10% each (totaling over 30%):

combinedA

combinedB

combinedC

However, those same opportunities could be traded with “two-to-one leverage.” If starting with $100,000, then the first profit (8% times two) would bring the balance to about $116,000. The second trade (at 2:1 leverage) would increase the $116,ooo balance by about 25% to about $145,000 (less than a month after opening the first trade). The third trade (still at 2:1 leverage) would raise the $145,000 by over 10% to about $160,000 (less than 2 months after opening the first trade).

Note again, that this 60% gain in under 2 months was not available in these markets most of the year. This strategy focuses on ONLY buying markets that at extremely discounted according to a particular measure.

There are other measures of sentiment besides the ones shown here. There are also many other markets ( besides the 12 shown here) that have easily accessible sentiment data, such as bond markets, currency forex markets, and commodity markets (gold, crude oil, etc…).

So, if using this method in just those 12 markets, there would have been 10 months of no risk (like just collecting interest in a money market account). However, the same logic can be used to buy discounts in other markets, as well as to profit from markets that have extremes of positive sentiment.

Or, other trading methods could be used so that the same select few opportunities (in those 2 months of extreme discounting) could be used to make much higher profits than 60%. For reference, I will display a quick example of a gain of about 70% (which happened overnight, though I made the purchase two days prior to selling):

options

When three quick gains as large as 70% each are compounded in only a few weeks, the total gains can quickly become quite large. Even though this trading strategy of buying only extreme discounts is highly reliable, most investors who use this last method will use it in combination with one of the other two methods, which mot people find to be much easier to execute (though the compounded profits may be smaller).

I personally use all of the above three trading methods, often at the same time. The three methods are again cash trading of unleveraged markets, ETF trading (usually of markets leveraged 2:1 or 3:1), and trading of option contracts. Further, I do use other forecasting strategies besides the one identified here regarding buying only extreme discounts.

However, the forecasting strategy of targeting sentiment extremes is the best strategy that I know, but there are periods of time when none of the dozens of markets that I track are at such an extreme of sentiment that I would use this strategy alone. Buying discounts is the easiest strategy to explain and also relatively easy to implement.

Interested in having a highly-skilled trader manage some or all of your investment accounts? If so, contact me!

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