happened on several fronts. Students of the gold market and ofchart patterns (which is called technical market analysis) saw thetriggers and took action accordingly. Figure 6.5 shows one ofthese triggers in chart form.
THE GENERAL INVESTMENT MODEL
FIGURE 6.5
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Gold triggers an up move by penetrating the “resistance level.”
ResistanceLevel
SUMMARYNow that I have shown you the GIM and STF and explainedsome of the details, there are a few more issues that need to beaddressed. The following questions and issues are probably onyour mind. Rest assured they will be answered. For now, I askyour patience and commitment.
How can I begin with only a few hundred dollars?

How can I get the money to begin investing, if I don’t haveit yet?

How do I know if I’m trying to move ahead too quickly?
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How do I know if I’m moving too slowly?

Should I try to have opinions or just follow rules?

Are opinions worthwhile or just potentially problematic?

Should I try to do this alone or with a partner?

What, if any, are the dangers of working alone?

What, if any, are the dangers of working with a partner?

Are you capable of going it alone, or are you more likelyto be successful with a partner or partners?
Chapter 7 will put the model into practical application foryou. Get ready, the best is yet to come.
C H A P T E R
S E V E N
THE METHOD
In order to put the GIM into practice, you will need a methodthat tells you exactly when to buy, when to sell, how much moneyto risk, and when to get out of an investment. The process of actually determining what and when to buy or sell is called “timing.” Timing fits into the confirmation step of the GIM. Whetheryou are a long-term investor, a short-term investor, or a day trader,the timing method that will be explained in this chapter can helpyou on the road to success. Because timing is extremely important, the information contained in this chapter is vital to yoursuccess. Although the information presented herein may beslightly technical to you, take your time and read it carefully.In fact, study it as you would a science book. If you are havingdifficulty with the concepts or the charts, see the introductorybook I wrote with my son Elliott, Stock Market Strategies That Work(McGraw-Hill, 2001).
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In this chapter I will give you the tools you’ll need for investment success: how to implement the GIM model and STFmethod with timing.While some of you may think that this is the most importantchapter in the book, I assure you that this is not the case. Thischapter reveals no secrets, no magic potion, no instant get-richquick fairy dust, and no surefire success method. Instead, thischapter will expand my logical, step-by-step, no-sex-appeal methodfor guiding you to financial success. If you want sex appeal andsecrets, watch late-night television infomercials and read yourjunk mail. “These wonderful secrets can be yours for only 4 payments of $49 plus shipping and handling. And if you order withinthe next 30 minutes you can also get the Do-It-Yourself InstantMega Millionaire Kit at no additional charge. If you’re not totallysatisfied, you can return the entire package within 30 days for afull refund (minus shipping and handling).” No, you won’t findany of that in this chapter. But you will find logic, consistency, andtime-tested suggestions, which when combined with the GIMand STF methods will help you along the road to success morequickly than you had hoped or expected.
SELECTION AND TIMING OF INVESTMENTSThis seemingly simple topic has been the subject of thousands of books, hundreds of seminars, and thousands of articles.You can’t buy a copy of Forbes magazine or any of the numerousother financial publications without being exposed to recommendations and suggestions. I’m sure you’ve seen the provocative headlines . . .
Ten Stocks to Buy Now for Your Retirement Years
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Stocks That Can Double Next Year

Riding the Profit Wave of Biotechnology

Gold Stocks for the Small Investor

The Power of Options Trading

High Income Stocks for the Higher Risk Investor

Properties to Buy Now for Tomorrow’s Big Profits
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The sad fact about most, if not all, of these alluring headlines is that they are designed mainly to entice you to buy thepublication. If you examine the recommendations in retrospect,you’ll find that many of them failed to pan out. What’s worse, inmany cases the recommendations went bad before they turnedto the good. And while the individuals who recommended thesestrategies or investments can come back in one year and statethat their strategies made money, they fail to tell you what happened in the interim. For example, if a stock was recommendedas a buy at $30 per share and it declined to $10 per share thereafter, many investors would have bailed out, taking the loss. Ifthe stock thereafter went up to $44 per share, the individualswho recommended the stock can state that they were correct intheir forecast. In the long run, the recommendation mademoney IF you did not panic and sell when the stock declinedand IF you had the patience and emotional strength to hold onand IF you didn’t get out at the first sign of recovery in the priceof the stock. Skillful financial writers, analysts, or stock pickerscan pull the wool over your eyes and look good when they are,in fact, wrong. There are only a handful of market timers outthere in the investment world who have been consistently goodat their job. (I name names in the Resources at the back of the
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book, but don’t go there yet!) I want you to be your own expertand your own stock picker. I want you to become independent.Remember that there are basically five types of experts inthe investment field. They are as follows:1. The biased expert. Forget about these people! They usuallywork for brokerage houses. Because of the stock-pickingscandals that surfaced in the early 2000s and changes implemented to avoid such problems in the future, manybrokerage houses have separated their research departments from their sales departments. Many independentresearch firms have come forward as alternatives. Thismay prove helpful. However, I strongly advise you to avoidany brokerage house research and recommendations, because they will likely be biased sooner or later.2. The general trend follower. These individuals are good at analyzing and forecasting the general direction of markets.They can correctly forecast pig-picture trends—the direction stocks are likely to move over the next three to fiveyears and the outlook for the real estate market. Such information can be helpful but in some cases is not specificenough. However, the work of some good general trendfollowers out there is worth following.3. The marker timer. These individuals have a shorter-termfocus than the general trend follower. They want to pickmarket turns that are shorter term in nature and seekto move in and out with the twists and turns in stocktrends. There are several excellent market timers butthey are subject to some of the limitations we will discusslater on.
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4. The stock picker. There are thousands of stock pickers whoclaim to have excellent records. In most cases, their workis less than 50 percent accurate. They make their moneyby getting out of losing positions quickly, while ridingwinning positions for a longer time. Following a stockpicker has its good points and its bad points. The goodpoints are you don’t have to do the work yourself andthey’re good at what they do. The bad news is they havetheir downtimes as well as uptimes and you’ll have to payfor their services. Finally, some stock pickers and markettimers are better in some areas than in others. Some areespecially good at mutual fund timing, whereas othersare excellent gold stock pickers. If you want to have abalanced list of investments, you may need to follow agroup of experts and deal with opinions that are, at times,contradictory.5. The sector expert. These people excel in one area or another. They are highly focused, tend to have tunnel vision,and are all too often fanatical in their points of view. Youwill find many of the “gold bugs” in this camp. The goodnews is they usually know their stuff. The bad news is theywill often stick to their expectations through thick andthin and all too often their timing is bad. They may continue to recommend a given strategy, even if it has beena losing one for many years. Eventually, they will be rightand they’ll never let you forget it! Don’t get me wrong.There are some excellent names in this area but don’tgo here with the intention of putting all your eggs in onebasket. Diversification is the name of the investmentgame!
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INTRODUCING THE METHODIt is difficult to write an investment guide that will be tailoredto the level of expertise of all investors. Some of you may be completely new to the stock market, while others will have had manyyears of experience. If I begin at too basic a level, I run the riskof alienating those with more experience. If I begin at too advanced a level, I’ll lose the beginner. Accordingly, please findyour place in the following list and act accordingly:
Complete newcomers to investing. If you have had no experience in the stock market, you need to learn the basic terminology of the market. If you have no experience in realestate, you’ll need a working knowledge in this area as well.I suggest reading Stock Market Strategies That Work. It willhelp you become acquainted with the basics and with manyof the important issues. There are other books for beginners that may be more basic. It may take a little more timefor you to get started, but I urge you to build a sound baseof knowledge before you invest a single penny in stocks.

You have had some experience but . . . This category is onestep above being a newcomer, but it’s an important stepbecause you have learned some of the basics. Here again,I recommend my book Stock Market Strategies That Work.

You’re an experienced investor. This means you have tradedin stocks, options, futures, or all of these. You have a goodunderstanding of the terminology used in stock investingand trading. I suggest that you read my books, MomentumStock Selection (McGraw-Hill, 2001) and How to Trade the NewSingle Stock Futures (Dearborn Trade, 2002). These bookswill help you with the concepts discussed in this chapter.
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As an alternative, you may want go ahead with this chapter,regardless of your experience level. If things don’t make senseto you, then go back to the basics and read the recommendedbooks. Note that there are many books for beginners, so chooseone that you enjoy or that is more on your level of knowledgeand experience. Now let’s proceed with the topic at hand.
Many Different MethodsThere are literally thousands of investment and tradingmethods in the stock, options, and futures markets. Truth beknown, most of them are only marginally successful for variousand sundry reasons. If you can find a method that has beenprofitable 50 percent of the time, and if you manage your losinginvestments by exiting them quickly while you keep winning investments, you will do well in the long run. Few professional investors are correct a majority of the time. Too many investors arepreoccupied with the question, What percentage of the time hasyour investment decision been correct? The question is not onlya foolish one, but it can also get you into trouble. The importantquestion is not how often has a system or methodology beenright, but rather how much money has an investment methodmade for individuals at your financial level.Consider the following scenarios:
Investor #1: Ten investments at 90 percent correct. Oneinvestment lost money, the others made money.

Investor #2: Ten investments at 30 percent correct. Seveninvestments lost money, only three made money.
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Which of these two is best? Most people would pick the investor #1 approach, but the choice would be impossible to makewithout more information. Consider the following:
Investor #1: Ten investments at 90 percent correct. Oneinvestment lost $2,000, the others made a total of $457 aftercommissions. Net LOSS: $1,543.

Investor #2: Ten investments at 30 percent correct. Seveninvestments lost a total of $2,500. Three investments madea total of $5,000. Net PROFIT: $2,500.
Which of these two is best? Clearly the second choice is thecorrect one. Note that for investor #1, accuracy was excellentbut the results were poor.
Investment Methods, Accuracy, and RiskAs you can see from the foregoing example, accuracy is notthe issue. If you have a method that is both accurate and profitable, you have the best combination. Although this chapter isabout an investment method, I will tell you frankly that if youmanage your risk correctly, then virtually any method can makeyou money if you follow some basic rules. These rules are discussed at the end of this chapter. I believe that the methods discussed in this book can boost your accuracy well over the 60percent level. This advantage, combined with effective risk management, can give you excellent and consistent results for manyyears.
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INTRODUCING MOMENTUMThere are many ways to measure the strength or weakness ofa stock. There are many ways in which we can attempt to determine if a stock is ready to go up or down. Momentum is one ofthe many technical methods used to measure the strength orweakness of a stock. I will use the abbreviation MOM for momentum. I like to think of MOM as a measure of underlyingmarket strength or weakness and of change in direction (ortrend). In fact, I like the analogy of fuel in a gas tank. If a stockis going to continue to move higher, it must have sufficient fuel,or momentum, to do so. If a stock or futures contract is goingto continue going down, it must have sufficient fuel, or momentum, to push it lower. If a market is moving higher, while its momentum, as measured by the MOM indicator, is moving lower,the market is in danger of topping. If a market is moving lower,while its MOM indicator is moving higher, then the market isdeveloping a bottoming pattern.Each of these conditions is defined as a divergent condition.Divergence means moving in different directions. Markets thatare likely to change direction tend to develop divergence beforethey change direction. Divergence does not always happen prior to achange in the direction of a market, but it often does. Why is thisimportant? Because if you are going to make money on yourinvestments, you will want to buy when markets are either lowin price or likely to go up. And you will want to get out beforemarkets go down, or soon after they begin going down. You willtake your profits and put them into other investments using thisapproach.
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The Normal SituationFirst, let’s take a look at the “normal” conditions for priceand momentum. Figure 7.1 shows a normal uptrend (bull trend)in which momentum and price are moving up together. This isa “healthy” market, one in which a top is not likely at this time.Figure 7.2 shows a declining trend (bear trend) in which priceand momentum are declining. This is also a “normal” pattern inwhich the odds of a continued drop in price are quite good.
FIGURE 7.1 This illustration shows momentum with price. Note that as pricemoves higher, momentum moves higher. The “vehicle” has fuel behind it and, asa result, a top is not imminent. Of course, this can change quickly, depending onthe behavior of the MOM indicator.
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FIGURE 7.2 The relationship between momentum and price as price declines.As price moves down, momentum becomes more negative, suggesting thatthere is still power behind the declining trend.
HOW TO CALCULATE MOMENTUMDon’t let this scare you; MOM is simple to calculate. You donot need to know how to calculate momentum, but if you wantto know, remember that it involves simple subtraction. In order toget the MOM indicator, you simply subtract one day’s closing pricefrom the closing price X days ago. Here are a couple examples:1. Ten-day momentum calculation for stock ABC. Price today:64.10. Price ten days ago: 64.50. Momentum = 64.50 −64.10, or −0.40. The momentum is NEGATIVE, becausethe price today was lower today than ten days ago.
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2. Ten-day momentum calculation for stock XYZ. Price today:2.22. Price ten days ago: 2.18. Momentum = 2.22 − 2.18,or +4.0. The momentum is POSITIVE, because the pricetoday was higher than ten days ago. Momentum is zero ifthe price today is the same as it was X days ago.Some trading software and charting programs use the Rateof Change (ROC) instead of the MOM. The calculation forROC involves dividing one number by another rather than subtracting. In terms of the shape of the momentum indictor whenplotted on a chart, however, the end result is the same. As I saidbefore, don’t let this discussion scare you. You will not need toknow how to calculate MOM, unless you do not have access tothe Internet. If you have access to the Internet, either throughyour own computer or an Internet facility, you can get the MOMonline, usually at no charge.
WHAT DOES MOMENTUM TELL USABOUT A MARKET?I consider momentum to be a “fuel gauge indicator” for themarkets. Whether we use MOM for stocks or futures, it tells ushow much available energy a market has:
When a market is moving higher, momentum should bemoving higher.

When a market is moving lower, momentum should bemoving lower.
These two conditions are normal conditions for a market. Whenconditions become abnormal or divergent, that should alert usto possible changes in market trends.
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DIVERGENCE AND CHANGES IN TRENDThere are two conditions that can signal a pending changein the trend of a market. They are as follows:1. Bearish Divergence—PENDING MARKET TOP. This condition is signaled by price moving HIGHER, while momentum is moving LOWER.2. Bullish Divergence—PENDING MARKET BOTTOM. Thiscondition is signaled by price moving LOWER, while momentum is moving HIGHER.These conditions can be readily observed if you plot momentum on a price chart. The time length for MOM we will useis 28 periods. This length was determined through my study andanalysis of the markets. Take a few minutes to examine the illustrations in Figures 7.3 and 7.4, which show the positive and negative divergence conditions. By 28 periods I mean 28 days or28 weeks. The long-term approach I am recommending in thisbook is based on weekly prices. Therefore, the momentumwe will use is 28 weeks in length. In other words, the price atthe end of this week subtracted from the ending price 28 weeksago.I want to stress a few points before going on. Let’s go backto the GIM. Remember that the GIM consists of five steps. Hereis how these steps “work” in relation to the MOM timing method:1. Historical pattern. The historical pattern that leads us to expect a particular move in a stock is based on the theory andobserved history of momentum and price (as explainedin this chapter). The pattern is simple: A price higherwith MOM lower is a negative pattern (i.e., a sell pattern);a price lower with MOM higher is a positive pattern (i.e.,
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a buy pattern). The existence of a pattern does not leadto action; it merely leads to an expectation.2. Expectation. We anticipate that a stock will go up or downbased on the history of the pattern and its current configuration. An expectation is nothing more than an expectation.It is NOT a call to action. If you act on an expectation,you are not following the method.3. Confirmation. Confirmation in this case comes when theMOM indicator has given a signal to buy or sell as discussedin this chapter. The buy or sell confirmation is specificand 100 percent objective. There is no interpretation, nodeliberation, no analysis, and no deep thinking. The switchis either on or off.4. Action. Action is necessitated by confirmation. In this case,the action you take will be to buy or sell.5. Management. Once you have taken action, you will followthrough with effective management of risk in order tomaximize your profits and minimize your losses.
Examples of Bearish (Down) and Bullish (Up) DivergenceFigure 7.3 shows bullish divergence. You will note that as theprice of this market moves lower, the momentum continues tomove higher. To me this means that the market is being “accumulated” by traders who may either know or think they knowsomething bullish. In any event, the rising momentum with thedeclining price SETS UP a possible low. Note that this configuration does not tell you to buy immediately. It only sets up a potential low.
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FIGURE 7.3 Bullish Divergence. Note how momentum continued higher,while the price of the market continued lower into late January. As the pricewas moving lower, momentum was moving higher.
Figure 7.4 shows bearish divergence. Note that as the priceof this market moves higher, the momentum continues to movelower. To me this means that the market is being sold by traderswho may either know something bearish or think they knowsomething bearish. In any event, the falling momentum withthe rising price SETS UP a possible top. Note that this configuration does not tell you to sell immediately. It only sets up a potentialtop.The bullish divergence preceded an explosive rally in thismarket. Take a few minutes to study the chart in Figure 7.3. It isa classic example of how a change in the direction of momentum precedes the start of a new bullish trend.
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FIGURE 7.4 Bearish Divergence. Note how momentum continued lower, whilethe price of the market continued higher. The stock dropped substantially afterthe bearish divergence pattern.
It is important to remember that the illustration in Figure 7.3does not, in and of itself, tell us WHEN to buy. It only tells us thata change in the trend is likely. Sometimes the change will developwhereas on other occasions bullish divergence fails to developinto an actual signal to buy.Let’s go back for a few minutes to our STF discussion. If yourecall, I advised you to think of investments as having threeparts, the Setup, the Trigger, and the Follow-Through. Theprocess of finding stocks that have momentum divergence is theprocess of finding setups. The setup itself does not trigger an investment. Please read this carefully and understand it. It willmake you money and, above all, SAVE you money and preventyou from making blunders!
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This is why we need to use another aspect of the MOM to actually get us into specific stocks as investments. This topic will bediscussed next. First, however, let’s take a look at how bearish divergence precedes market tops. See Figure 7.4.Bearish divergence preceded a strong decline in this market. Take a few minutes to study this chart. It is a classic example of how a change in the direction of momentum precedesthe start of a new bearish trend.It is important to remember that the illustration in Figure 7.4does not, in and of itself, tell us WHEN to sell. It only tells us thata change in the trend is likely. Sometimes the change will develop, whereas on other occasions bearish divergence will fail todevelop into an actual signal to sell.This is why we need to use another aspect of momentum toactually get us into the markets.
TIMING, TIMING, TIMINGTiming is the critical element that investors and traders havefailed to understand correctly when using momentum. As I havestated above, the mere fact that divergence is developing doesnot mean that it’s time to buy or sell. YOU MUST WAIT FOR ASIGNAL. The MOM timing signal is very specific. Here’s howit works:
Buy signal. Once a period of bullish divergence has developed for six time frames (i.e., days if you are using dailycharts, weeks if you are using weekly charts), then youBUY when momentum exceeds the highest level it has attained during the period of bullish divergence. This condition is shown in chart form in Figure 7.5.
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FIGURE 7.5 The price of this market made a new low at point A. The new lowat point A was not accompanied by a new low in momentum at point B. As youcan see, momentum B is higher than momentum C, while price low A is lowerthan price low D. This establishes the period of bullish divergence. Point E is thehighest momentum point between momentum points C and B. The penetrationof point E at point X yields the momentum buy signal prior to a substantial rally.

Sell signal. Once a period of bearish divergence has developed for six time frames (i.e., days if you are using dailycharts, weeks if you are using weekly charts), then youSELL when momentum declines below the lowest level ithas attained during the period of bearish divergence. Thiscondition is shown in chart form in Figure 7.6.
Figure 7.6 shows the opposite situation. It shows how a topforms on bearish divergence and the sell signal trigger based inpenetration of point E, which is the momentum sell point.
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FIGURE 7.6 The price of this market made a new high at point A. The new highat point A was not accompanied by a new high in momentum at point B. As youcan see, momentum B is lower than momentum C, while price high A is higherthan price high D. This establishes the period of bearish divergence. Point E is thelowest momentum point between momentum points C and B. The penetrationof point E at point X yields the momentum sell signal prior to a substantial decline.
That’s it. It’s simple, but it will take you a while to learn howto spot the divergence and the signals. I do believe that afteryou’ve done this for a while, you’ll get the hang of it and you’llbe able to jump on board big moves, either before they happenor just as they’re beginning to happen. Although the momentum method is not infallible, I believe it can alert you to majormoves, either before they begin or in the very early stages of theirdevelopment. The momentum method can work in a differenttime frame as well. If you’re a short-term or day trader, you’llwant to use intraday charts in order to get the signals correctlyfor these time frames.
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WHERE DO I GET THE MOM?Now that you know the method, you will need to practice it.But practice requires you to have access to MOM charts. Thereare several choices:
Keep your own charts and calculate MOM on your own. This islabor-intensive and truly a waste of time, because you canget the MOM online for a small fee by subscribing to achart service (it may be free at some Web sites).

Subscribe to a charting service that will allow you to get a charton virtually any market with the MOM indicator on it. Theseservices vary in price from about $40 monthly on the lowend to as much as $700 monthly on the high end. You donot need to spend high-end money to get MOM charts.
The Resources section at the end of this book gives you thenames of services that are either free or fee-based for getting theMOM indicator.
PRACTICE, PRACTICE, PRACTICE!Now that you know the MOM method and can identify divergence as well as entry signals, the key to your success will depend on several factors, the first of which is practice. You mustbecome completely skilled at the application of the MOMmethod.
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Manage RiskOne aspect of success, as you well know, is to manage yourrisk effectively. This requires the use of stop losses based eitheron dollar risk stops or on a technical approach. If you wantmore information on this aspect of the MOM method, I referyou to my book Momentum Stock Selection (McGraw-Hill, 2001),which is available at my online bookstore, <www.invest-store.com/tradefutures>. This book will help you sort out the details of riskmanagement with this important trading method.
Practice ChartsBecause this method requires practice, I have included a fewpractice charts for you. These charts show various time framesand various markets, along with my analysis of the patterns. Icannot stress too strongly the importance of practice. Althoughthis method is simple and easily applied, it will take practice.Chapter 8 will give you specifics on how you can apply the MOMmethod to various investment budgets.Finally, I want you to understand this approach fully beforeyou invest a single penny. Therefore, if you have questions onthe MOM method, send me an e-mail at jake@trade-futures.com.You will get a reply as quickly as possible from either myself oran assistant, but please be patient because I get many e-mailsevery day.
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PRACTICE CHART 1 This chart shows a developing bearish momentumdivergence, because prices made a new peak but momentum was movinglower in early February as prices climbed. Eventually this market declined.
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PRACTICE CHART 2 This chart shows a classical momentum divergence lowpattern. Note how prices made a new low in early November, while MOM didnot do so. Eventually MOM went ABOVE its high point of the divergence period,which was established in the week of 29 October. This point was penetrated inearly November, after which the market moved dramatically higher.
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PRACTICE CHART 3 Here is another classic example of a stock that is clearlybottoming based on bullish divergence. As you can see, the MOM is rising asprices are declining. In fact, a low was made and momentum continued to climb.This stock will enter its BUY point if and when it exceeds the highest momentumlevel on this chart. This level occurred at the end of the week of 12 April 2002.
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PRACTICE CHART 4 Amazon.com bottomed in a classical MOM pattern. Asprices moved down, MOM was moving up. When the high point of the MOMdivergence period was penetrated (as shown by my buy notation), the stockbegan to go higher. It moved from about $14 per share to a peak of $25 pershare.
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PRACTICE CHART 5 This chart shows a stock that is now bottoming. As youcan see from my notes, a new low has been made in price, while MOM has beenrising. The buy point has been established and we are waiting for a TRIGGER tooccur.
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PRACTICE CHART 6 This chart shows two situations. First, a MOM divergencesell at the far left of the chart and, as of the end of the chart, a MOM divergencebuy setup. Can you find the proper points?
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PRACTICE CHART 7
A sell pattern is developing. Can you find it?
C H A P T E R
E I G H T
GAMBLE OR INVESTYOUR WAY TO WEALTH?
As an investor you have many choices. You can be conservative, aggressive, long-term oriented, or short-term oriented. Youcan be a day trader or mutual fund investor, or you can trade thenew single stock futures (SSF) market. What you decide to dodepends on a number of factors, the most important of whichare your financial ability, personality, self-discipline, level of experience, and available time. No matter what you decide to do,you must follow the time-tested rules of profitable investing.Although this seems like a reasonable and relatively simple thingto do, the sad fact is that most investors, even experienced ones,will not follow through consistently.Unfortunately, too many of us give in to the gambler withinus. After all, we believe erroneously, it takes much less work tobe a gambler than it does to be an investor. This