CHAPTER 1
Divergence Coupling
This book will differ some from its predecessor in that I'll needyou to access the Internet while you review the discussion. Let'sstart at http://www.optionarmy.com. Click Command Centerat the top. What opens next has several useful features. We will focuson two. In the left column, clicking Futures tells me of any overnightsurprises before I execute trades. I discussed this in Compound Yield. Forthis book, click Sector & Broad Market Analysis in the right column.This brings up a PerfChart. Below the graph is a list of ticker symbolsreflecting the subsectors of the S&P index. Clear the chart. Now enterUUP, which is an exchange-traded fund (ETF) bullish on the USdollar. Then add FXE, which tracks the euro. Do you see somethingamazing? Presently, in our crazy "stimulus" market, the US dollar andthe euro are exact mirror images. They are exactly reciprocal and inlockstep. When one goes up, the other ETF goes down and vice versa.This is so perfect that it's shocking.
Let's assume UUP to be a perfect company called ABC that willalways pay its dividend of 5 percent. Next imagine that FXE is also aperfect company called XYZ and will never fail to pay its 5 percentdividend. Now we size each to $20,000. Let's assume a share of eitheris $10. Each pays dividend installments on a quarterly basis. A share ofeither pays 12.5 cents every three months. Compound Yield tells us totake profits when a company's value has increased the equivalent of itsannual dividend and then reinvest the profits elsewhere at the same orbetter yield. Here, in this idealized system, every time either ABC orXYZ goes up enough to take profits, we would sell enough shares tofully capture the profit and reinvest in the other stock, back and forth,back and forth. Both have a 12.5-cent quarterly dividend. When wetake profits on ABC, our remaining shares still have the same yield.However, by investing now in XYZ, which went down exactly asmuch as ABC went up, our new shares are cheaper and therefore havea higher yield since the dividend is still 12.5 cents quarterly. When thereverse happens, we then take profits on XYZ. We know automaticallythat ABC went down in lockstep. By trading again, the yield on theremaining XYZ shares is preserved, and our new shares of ABC enjoya higher yield. Again, we are in a perfect system, and there is no failureto pay the owed dividend.
We are optimizing divergence pairings in such a way as to producean incredible cash-generating machine. By repeatedly trading back andforth, the combined value of the two companies stays $40,000. Thereis no lost principal because the stocks can't go down together. Theirmovement is equal and opposite. In essence, all capital gain is convertedto geometrically increasing income because of compounding. Theyield on cost ($40,000) keeps increasing. Also, because ABC and XYZmove reciprocally, we really don't have to care about market direction.The more market volatility there is, the better. Volatility provides thetrading opportunity. The more we trade, the faster our income increasesand the higher the yield on our cost basis.
In fact, let's do a little math. If either ABC or XYZ moved up 1%at some point in any given month, and we consistently executed tradeseach month, in one year's time, between the two positions, we wouldhave 12% more shares, and our average share would be at 12% lesscost. We are not even talking about the compounding effect of month-over-monthtrading. We are just talking about a flat 12% annually.Additionally, we haven't even included reinvesting the dividends comingin. We've just pocketed these. At the end of one year, our 5% dividendyield is now 12% larger at 5.6%; by the end of the second year, 5.6%becomes 6.27%; by the end of the third year, we're at 7.02%; and bythe end of the fourth year, we have 7.86%. Year over year extrapolatesto 8.80%, 9.86%, and then 11% at the end of the seventh year!
This is truly exponential income, and we haven't reinvested anyof our dividend stream. We've accomplished this by focusing onyield and compounding it. If we had reinvested, we would have beencompounding this compounding yield. I could only call this ultimatecompound yield. This is explosive and of profound importance in reachingour retirement income goals and maintaining these throughout ourretirement. You really should be breathless now!
Unfortunately, it's not easy to find great diametric pairs and securitiesthat are perfect in paying the promised dividend. On the other hand,ABC and XYZ aren't raising their dividends with time, and we wouldexpect our real world choices to do so. When a dividend is raised, we'vebeen God blessed as the effect gets magnified. We have been reducingthe overall cost of an individual share and increased our total numberof shares. Every share pays a dividend. You have my permission to blackout now!
By using all of the risk-management techniques taught in CompoundYield, I think we can realistically achieve 70 percent to 80 percent ofour idealized model. For those not already retired, reinvesting dividendsshould massively amplify success. The rest of this book concerns itselfwith achieving near-perfect ultimate yield. As we go, you'll be amazedwith how plan execution simplifies to the point that references tomindless income are neither deceptive nor misnomers. Having readCompound Yield, you know my philosophic and spiritual perspective. Weare accessing here the perfection of what God's universe has to offer usmathematically. All I know is that I greet each trading day with hope,optimism, and conviction. If you are not sitting on the edge of yourseat with your heart palpitating, please close the book. Your time mightbe better spent trying to find some sugar daddy or sugar mama to takecare of you in retirement. Don't count on our government to save youeither: it will be broke.
Now, ready for some more math? Again, Compound Yield focuseson trading when a position has moved the equivalent of one year'sdividend. By doing this and reinvesting elsewhere with the same yield,we essentially doubled that position's return with just one trade in ayear. Growth to Exponential Income takes trading to once a month. I thinkyou will be delighted to see how little your positions need to changeto do this consistently. All of our trades continue to be safe as we neverlose on a trade. We continue to know the outcome before we take anytrade. We still don't leave food on the table. We still continue to takeprofits to buy income. By increasing the frequency of trading, we'reactually loosening up on how much a position has to move before wecan act. My rule of thumb will be 1 percent. When a position is up 1percent or more, we can take profits. We can buy down into a fallenposition of 1 percent or greater. Our only leap of faith continues to bethat we are confident that our holdings will meet dividend obligations.We let the market go where it may, and we rarely deviate from theplan outlined in Compound Yield. I've chosen 1 percent for convenience,particularly convenience of discussion. One percent movement on a$20,000 position is only $200. How often does that happen? It happensdaily, and we need to take advantage of this only once a month. Do yousee anything here to worry about? I hope you answered no. Remember,I created the compound yield formula to reduce my own anxiety. Thereis nothing here to let yours get away from you! And, now you might beon to me. Once I have reached the annual income I want to retire on,I'll hire myself part time to essentially day trade for long-term income.Recall that I showed you that ABC and XYZ had a dividend growthrate of 12 percent just by trading once every month. I'll work harderthan that for my boss (me) so I can get an annual raise of 12 percent ormore. I'll be able to quit my day job!
CHAPTER 2
What I Believe
My friends (I am being quite sincere when I make this reference:we certainly could be—I just haven't met you yet), youknow a lot about me by reading the first book and are herewith me in the second. Reciprocally, I know and like some things aboutyou. You, as I, are partially or wholly contrarian. You are not contentto sit back and allow your money to be managed professionally formediocre and often poor results. You've decided to take charge of yourretirement account and retirement future. Essentially, you are made ofthe stuff that once made America great. It certainly took contrarianthinking to free ourselves from British rule, put a man on the moon,and create computers for personal use. You are free thinkers who wantto be responsible for yourselves. This likely has been a pervasive themecharacterizing your lives. You are likely strong supporters of your placesof worship, are generous with friends and community, and worry aboutwhat kind of future your children and grandchildren will live through.You and I are very alike indeed.
I am not an expert in finance, nor am I a professional trader. Havingbeen a physician for many years, and almost by default, I have becomean expert in human emotion. I've seen the best a human being canbe through watching my physically impaired rehabilitation patientsbecome heroes to their families by their resilience, perseverance, andstrong desire to not be a burden. In my practice, I've shared in thegrief of family members trying to cope with addictions and all theaccompanying destruction. I had to provide honest and committeddirection to save lives and not just cure illness. I am here to talk to youabout emotion, as I do qualify as an expert here, and I want to tell youa few things about the market that may nauseate you. You may not besurprised as you are a contrarian, but you may be nauseous just the same.Have your antiemetic ready.
The only thing real is income. Everything else is emotion, and it isgamed criminally from an ethical perspective, though perhaps not sofrom a technically legal one. What goes on behind the scenes can bequite sinister. I'll prove it to you in a very real way. I want you to takea dollar out of your purse or wallet. What you have is a piece of paperimmediately recognizable as legal tender with a nice picture of GeorgeWashington on it. You would tell me that it is worth one US dollar.If you showed it to a friend, he or she would confirm that it is worthone dollar. We would all agree. Let's get back on www.optionarmy.com. Click Command Center and then Futures. Find the weekly timewindow, and click it. Now look down to the bottom where you willsee green, red, and blue lines. The green one reflects what commercial/institutional money is doing (Wall Street, colossal investment banks).The red line reflects what large traders are doing. The blue one reflectssmall investors like you and I who are just consistently contributingmonthly to our retirement mutual funds. Get ready to take yourmedication now. Commercial money is huge, trading millions of sharesat a time. Large traders try to play off this for some short term profit.Our actions seem more passive by comparison. Now, compare this tothe S&P. You may notice that once commercial money starts to go long,a market bottom starts to form. Commercial money decided where itwanted the bottom to be. The market thereafter starts to go up, andthe amateur, uninformed and complacent money (my opinion, trustingour mutual funds blindly) is all getting ready for slaughter. The bottomis set because more money is trying to buy shares than there are sellersto sell shares. More willing sellers come in only when price rises. Bigmoney keeps driving up prices, and more "investors" notice and golong. This further drives up price and starts to create a fever of buying.Greed is in play here. Nobody wants to be left behind, and everybodygets on board. At some point, things top out, and commercial moneyhas something to do with that, as well. Commercial money knew whereit wanted its price to go, takes profits, and starts to short. Price starts todrop, and you and I get the great idea to sell and short, as well. We allare driving price down. Now guess what happens—commercial moneystarts pouring in like crazy and also closes its short positions. It is settingthe bottom for the next rally. This quickly becomes a short-selling rally.The emotion here is fear. Fear is a stronger emotion than greed, andnear panic follows. If price is going up, then shorts are hemorrhaging.No one can get out fast enough, and price usually climbs quickly.Who do you think is buying all these shares for cheap? You guessedit—commercial money! The big boys are always on the front of all theseactions. You and I get in and out late and make no money or lose ourshirts. The ride down in fear is often faster and harder than the greedride up. Just look at a few charts and eyeball the slopes. That's why youmay hear it said that you can make more money when things go down.All of this is trading. Each mutual fund has rules of investing withwhich it must comply. Many can't short, leverage, or reverse leverage.They get taken to the cleaners, as do you and I. How's that for a levelplaying field? Are nauseous yet? Should I stop? The only place wherea dollar is worth a dollar or the share price is at true value is when thegreen, red, and blue lines intersect. Then everyone is in agreement.The vast majority of time is spent out of agreement. A lot of this timeis created by mistruths, lies, and misleading information.
Now that you feel so well treated, listen up, my friends: You areabsolutely necessary for this country to survive. You and I have to payfor it. We are the shakers and bakers. We are the entrepreneurs, businessowners, and employers. People are generally employees because theydon't have the skill sets to be employers or don't want the headaches.Who will be left to take care of everyone should we be gone or are leftin near poverty for retirement?
I treat my retirement like a business. I don't hire growth stocksbecause they can't do the job. They don't produce income. Low-dividendstocks are stingy. I don't hire these either. I have little interestin employing a lazy employee. I do give an employee (my position/stock) the benefit of the doubt when I buy down into it. However, ifthis gets to be a trend, I've been lied to, and I terminate employmentby selling it. I helped protect myself by buying down with profits fromsomewhere else. I also had sized the position.
I haven't forgotten that I am also a kind and benevolent compoundyield shark. I just want people to be happy. I want to give people whatthey want. If they want my shares, I sell them—but for a profit. NowI'm happy, too. If people are running scared, I'm happy to take sharesoff their hands and buy dividends on sale. No one needs to suffer whileI'm around.
I hope you've found my mental constructs to be amusing. I keepthem fresh in my head. They help me stick to the plan. I hope they alsostick in your head. Always strive to stick to your plan. I have it nowdrilled into my head: sell greed and buy income at a discount. Thequickest way to destroy risk management is to deviate from the plan.Any honest trader will tell you that he or she blew up trading capitalmore than once by deviating from the plan. Avoid trying to tweak theplan into some hybrid: you'll blow up your retirement. Should youfeel the need to tweak, make a self-assessment, create a new plan, andstick with that. I don't want you to blow up. You need to be one ofthe millions who will join the cause and help stabilize the marketplace.Take this on as your mission.
It is in my best interest to help you as much as I possibly can and tochallenge your opinion by mine. It is your nature to look at what I'msaying with healthy suspicion. I will tell you everything I'm doing in myportfolio. I am 100 percent invested using compound yield principlesto produce exponential income. I need all of us to survive and prosperbecause our country's spending is out of control, and we'll be the mainones shouldering the taxes.
I needed to create an approach that does not have to predict marketdirection. I had to build in strong risk management because I amnot a financial advisor, economist, day trader, or crystal ball holder.I'd like to be a more simple man and live a long retired life. If I canhelp the most people have the most success from what I'm doing orsomething similar (selfless), my needs have the best likelihood of beingmet (selfish?). I'll benefit from the sale of books, but more importantly,getting enough people to succeed will slowly start to stabilize themarket. Then, otherwise sidelined, trillions of cautious dollars will startcoming back to the market. Since I'll be selling for profit, I'll have littleworry about money. I'll be giving selflessly to receive my own wants,needs, and, dare I say, selfish desires. I can live with that!
I hope you will enjoy the process to create exponential income.Writing Compound Yield and now this book has renewed passion in mylife, and I'm thankful. I ask that you do me and yourselves a favor. Don'tgive away these books; they will fall on deaf ears and closed minds.Instead, talk about what you see and understand and how your financiallife is changing. Invite others to purchase the books for themselves. Wereally want lots more people to succeed. Let's not poison the chance tohelp someone by robbing them of motivation. It would be a shame tonot have these books read because they were free. It is human nature tominimize the importance of free information, especially when it comesfrom friends or family. Let's not do them a disservice.
CHAPTER 3
Optimizing Divergence
We sell into greed (positions rise), and we buy fear (positionsfall, and we increase yield buying dividends on sale). Thiskeeps us always selling high to buy low. We describedthe perfect security pair, ABC and XYZ, to produce geometricallymagnified income.
This chapter and the rest of the book are designed to get us as closeas possible to this ideal. In the process, as I promised, we'll be able tosimplify execution. The real world and real world markets generally donot line up ideally, but we can spot nearly ideal trades and take them.Our risk management helps us take profits off the table to more easilysee where divergence is picking up. Reciprocal trading continually helpsus minimize the value difference between members of a pair so thatwhen a change in price occurs, we simply spot it.
