Be sure to read our top tip today for important research results
combining Expected Gain and the Sell Assistant

Market Summary

Our market model signaled 'enter' for the NASDAQ market on Monday and that was the only one of the three major indexes to close higher for the week. The NASDAQ added 0.68%, helped by two accumulation days and only one distribution day, while the DJI lost 0.36% and the S&P 500 slipped 0.17%. Although the trend for all three indexes is upward, there are strong swings day-to-day as the tension between competing market forces resolves itself. Interest rates continue to be investors' main focus and the market rises and falls as each day brings different ways to interpret the Fed's intentions. Other factors affecting market movements currently are consumer confidence, which seems to be slipping, corporate profits, which have been generally satisfactory, energy costs, which fluctuate in line with geopolitical events but are unlikely to go down long term, labor costs, which are increasing and applying inflationary pressure, and bond yields, which are increasing and can attract funds away from equities.

Our focus here is usually on the NASDAQ because that is the market that most closely tracks the N in CANTATA. The switch in our market signal this week was positive and the index is now well above the 50 day moving average after several days below it in early February. It has recovered from support three times during February as the following chart shows, but failed to sustain itself above the most recent resistance level on Wednesday. Should it rise above that level then further resistance waits at the high of the year and penetration of that level would be bullish.

The number of successful breakouts stayed at a below average twenty-one this week, with the average gain of 1.04 % beating the market averages. Only two breakouts rose out of range with ASE Test Ltd (ASTSF) closing 11.71% above its pivot and Diversa Corp. (DVSA) gaining 6.26% above its pivot. Although all breakouts are comfortably beating the market averages this year, the return on our TradeWatch picks is over 7% and the annualized return is 64%.

Machinery-Construction/Mining continues to top our industry list ranked on technical strength while Beverages-Alcoholic was the most improved in the rankings.

Profits can be over 100% when combining Expected Gain with the Sell Assistant

Our Expected Gain model attempts to estimate the gain a breakout might achieve. The model is run twice for each potential breakout: firstly while a stock is on the CwHwatch list and then on the day of breakout when the breakout day volume is known. Several factors have caused us to revise the model:

• Our Expected Gain model was developed in late 2004 using data from breakouts between April 1, 2003 and September 3, 2004. Those results were affected by a strong recovery during 2003 and since then we have seen much slower market growth and we have a lot more breakout data to analyze now. Rebuilding the model using the data now available should provide a better model because it will encompass a greater variety of market conditions.
• During the last few months of 2005, we put a great deal of effort into developing new metrics allowing us to significantly improve the probability of selecting successful and profitable breakouts. It was essential to see if those metrics improved the quality of the model.
• We thought it would be very interesting to combine the results of the Expected Gain after breakout, which enables a buy order to be placed at the following day's open, with our Sell Assistant to see if a wholly mechanical system for buying and selling breakouts could be achieved.

We are absolutely delighted with our finding which we believe is the most important result our research has delivered yet. These results show that one can buy on confirmed breakout at the open on the following day and sell at the open following a sell signal and realize annual returns up to 150%.

This is achieved by buying confirmed breakouts where the expected return is greater than two standard deviations from the average expected return and selling when the Sell Assistant issues a sell signal. Following this strategy since April 2003 would have yielded the following returns:

These results were obtained by running the expected gain model on all successful breakouts since April 2003 through to 12/31/2005. The average expected gain was 48% and the standard deviation 25%. We selected all stocks with an expected gain >= 100% and then ran them through our Sell Assistant using the open price on the day after breakout as the buy price. The gain was calculated using the open price on the day after sell the signal was issued. These gains were therefore completely realistic because they depended only on the open price on the buy and sell date which is available to every investor.

This strategy may leave you with insufficient positions open at any time to allow you to be fully invested (if that's your goal) so we also ran the simulation on all stocks with an expected gain greater than 1 standard deviation above the mean expected gain. These results were also very impressive and should provide more than sufficient open positions for your portfolio.

The results of these backtests are available in an Excel spreadsheet here. This spreadsheet contains four worksheets showing the positions that would have been held using the 1 standard deviation and 2 standard deviation strategies and also positions that would have been held if the stock was only bought at the next days open if the price was within 5% of the breakout price. There is more on this strategy in next week's newsletter.

The expected gains shown in CwHWatch and the Recent Breakouts report will use the new expected gain model effective Monday, March 6. The Sell Assistant is accessed through TradeWatch so TradeWatch subscribers will be able to apply this strategy from then.

We will introduce a new TradeWatch list based on confirmed breakouts that have an expected gain of greater than 75% (approximately one standard deviation above the mean expectation) in the very near future.

Methodology

The methodology used to develop the Expected Gain Model was similar to that described here. There are three important differences this time:

1. We ordered the total number of breakouts (3125) sequentially and then split them into two groups by assigning them alternately. This provided us with one group on which to develop the model and another group as a control.
2. We used the highest intraday gain reached in twelve months after breakout as the variable to be modeled (the dependant variable) rather than the overall highest intraday gain. This is because we believe most CANTATA investors will not expect to hold a stock longer than 12 twelve months. If a stock dropped to -8% of its breakout price before achieving a maximum gain of at least 5%, then the maximum gain before the failure was used as the observed maximum gain.
3. We derived the Expected Gain model on the first group and then applied it to the second group and found the distribution of expected gains was very similar to the first group, confirming the validity of the model.

To obtain the results quoted above we applied the model to all 3125 breakouts to obtain an expected gain for each of the breakouts. We then selected those breakouts with expected gains exceeding 1 and 2 standard deviations and passed each of them through the Sell Assistant using the open on the day following breakout as the buy price. We used the open on the day following a sell signal for each breakout to calculate a gain/loss and the number of days the position was open. The Sell Assistant does not depend on price alone to issue a sell signal so a stock can fall at least 8% below the breakout price without a sell signal being issued. The Sell Assistant uses price, previous support/resistance levels and volume to determine sell signals and is described here.

If you think our service has great potential but you are too busy, or lack the technical analysis skills to apply our methods, you should consider talking to one of the investment advisors listed below.

Investment Advisors Using our Service

TradeRight Securities, located in a suburb of Chicago, is a full services investment management company and broker/dealer. They have been a subscriber, and user, of BreakoutWatch.com for some time now. They practice CANTATA and use Breakoutwatch.com as a “research analyst”. You can learn more about TradeRight Securities at: www.traderightsecurities.com. If you’re interested in speaking to a representative, simply call them toll-free at 1-800-308-3938 or e-mail gdragel@traderightsecurities.com.

PivotPoint Advisors, LLC takes a technical approach to investment planning and management. A breakoutwatch.com subscriber since May, 2004, they use breakouts, market signals, and now TradeWatch to enhance returns for their clients. Learn more at http://pivotpointadvisors.net or contact John Norquay at 608-826-0840 or by email at john.norquay@pivotpointadvisors.net.

Note to advisors: If you would like to be listed here, please contact us. As a service to those who support us, there is no additional charge to be listed here.