Monday, December 26, 2011

Season's Greetings


This is the time of year when we should step back from the markets and think about what has true significance in our lives.  December is a month of celebration for people everywhere.  To those of you who visit this blog from around the world, I offer you my best wishes as you celebrate Ashura, Bodhi Day, Boxing Day, Channukah, Christmas, Kwanza and Las Posadas.

If I failed to include your particular way of celebrating this time of year, please believe that my attempt at a global greeting in this time of peace and family extends to you and yours as well. 

Please feel free to comment and share your particular way of celebrating this blessed season.

We will return to the markets and technical analysis next Monday.

Monday, December 19, 2011

The Trend Is Your Friend - Moving Averages


Warren Buffett said that once he had purchased a stock, he could forget about the market and its gyrations.  Al Frank had the following to say in his classic, Al Frank's New Prudent Speculator:

Still, we do know that markets have fluctuating periods of advancing and declining cycles.  Markets become overvalued from time to time and thereafter decline, after which they become undervalued and subsequently advance.  Markets alternate: they become overbought, and thereafter sell off, after which they become oversold - which lays the foundation for the next rally.  These swings from overbought and overvalued to oversold and undervalued are not neat, nor are the turning points easily predictable, if at all.  Market movements are further complicated by the nature of short-term, intermediate-term, and long-term "trends", which sometimes yield conflicting current readings

When technical investors are poring over their charts, what are they looking for?  There are any number of signs to be divined by the chartists, but discovering the overall trend of a stock or a market is one of the most popular.  Studying moving averages is one of the most basic exercises of the technical analyst.  A moving average ("M/A") provides the price history of a stock or a market. Each analyst has his or her favorite time period for looking back.  The speculator or trader looking at an individual stock will create a chart showing an M/A for the stock over a set time frame.  One of the most basic of these is the 10 day M/A for a stock.

We will create a 10 day M/A for an individual stock since it is easily calculated.  It helps to have graph paper on which you can create a vertical line of price numbers and a horizontal time line.  Since you are calculating a number which is the average price of a stock over a given 10 day period, your graph will show only that one number (the average price) for the 10 days going backwards (the chosen time frame).  For our example, you will keep track of a stock's price over 10 consecutive days.  When you have prices for 10 days, add the prices up and divide by 10, which gives you your first average.  Note that on your graph.  Each day thereafter, you drop the price of the stock 11 days ago and add in the latest price.  You then recalculate the average for the new 10 day period and plot it on your graph.  Over time, as you do your daily calculations and add the results to the graph, you will start to see one of three trends:  the stock is going up, down or remaining unchanged.  Technical analysis holds that each of these trends can provide insight into where the stock price may be headed in the future.

Since you are creating your own chart, you can pick any time line for your average: 5, 10, 30, 45, 60 or 200 days or any other number of days of prices.  It is a personal decision as to how many days to use in creating your M/A.  Regardless of the number of days used, the exercise is the same.  You drop the oldest price, add the newest and average them.  There is a very good explanation of time periods to use when creating your own M/A on the website, Trading  It provides guidance on tailoring your graph to your investment horizon, which is the time period over which you expect to hold your investment.  If you will be speculating over the long term, an M/A of 200 days may be what you want.  It would be of little value if you are trading on a daily basis since it will not provide the immediacy you need.  Conversely, if you intend to trade or speculate over an intermediate period of time (45-60 days), a 10 day M/A does not give you the longer term chart your investment strategy may need.  

If the analyst is looking at an entire market, he or she looks to the Advance/Decline Line ("A/D Line"), which is the ratio of the number of stocks in the market going up compared with the number of stocks going down over a prescribed period of time.  If there are more stocks rising than falling, then the A/D Line is telling the chartist that the market is on the rise.  If the declines exceed the advances, the chart is indicating future declines.  We will be looking at the A/D Line in greater depth in a future blog.

You will note that I use the words "speculator" and "trader" in this blog; not "investor."  This is intentional, since, as I said in an earlier blog, technical analysis lends itself to short or intermediate periods of holding a stock.  For the long term value investor, market moves are seen as less important.

The material from Al Frank's New Prudent Speculator by Al Frank, copyright 1995 by Al Frank, is used with permission of the copyright holders, the heirs of Al Frank.

Comments are always welcome.

Monday, December 12, 2011

Foundations of Technical Analysis


I have referred to fundamental investors as gold miners, digging for valuable nuggets of information on a stock and technical investors as hang gliders, riding the winds of market sentiment looking to profit from a stock's updraft or downdraft in price.  Technical investors are often referred to as "chartists" since they graph the action of the market and/or individual stocks.  They study their graphs of price movement and trading volume, looking for trends which reveal where market levels or an individual stock price might go (up or down) based on past performance. 

Technical analysis is grounded in economics.  I think that it also relies, arguably, on a  basic law of physics.  It is governed by the economic law of supply and demand first described in 1767 and borrows from one of the basic tenets of physics: Sir Issac Newton's first law of motion, published in 1687.

The law of supply and demand provides a model for analyzing what affects price in a market.  The rules apply regardless of what the item is; consumer goods, commodities, food, tuition for college, airplanes or financial investments.  If demand equals supply and buyers and sellers agree on price, the market is in balance, also called economic equilibrium.  If such is not the case, the law states that there are four possible outcomes, depending on existing circumstances in a market, for the price of anything for sale:

1.  If demand for the item increases (more buyers) and the supply of the item (how many are for sale) remains unchanged, the price will rise.
2.  If demand  decreases (less buyers) and the supply is unchanged, the price will decrease.
3.  If the supply of the item increases (more for sale) and the demand (number of buyers) remains unchanged, the price will decrease.
4.  If the supply decreases (less for sale) and the demand is unchanged, the price will rise.

Sir Issac Newton (1642/1643* - 1727) remains one of the most famous physicists of all time.   Since I had to take four years of Latin in high school,  I can't resist giving you his first law of motion in its original version:

Corpus omne perseverare in statu suo quiescendi vel movendi uniformiter in directum, nisi quatenus a viribus impressis cogitur statum illum mutare.

This is the scholarly version (during Sir Newton's time) of, "A body at rest tends to stay at rest; a body in motion tends to stay in motion, until it doesn't."  Technical investors believe that a stock price, whether rising or falling, will continue in that direction for awhile.  Their goal is to buy in early on the trend and sell out before it stops.  The moment in time at which the trend stops or changes direction is called the point of inflection.

I think the technical form of investing rests on these two principles. We will continue to explore this strategy in further detail in upcoming blogs.

Comments are always welcome.

* I use two dates for Newton's birth year since England's accepted form of annual calendar changed during his lifetime.

Monday, December 5, 2011

You Have to Follow The Money - What Is The Price?


Chartists map the action of the investment in which they are most interested.  This could be a particular stock, an entire market, a commodity or anything else with a readily available market price.  Al Frank was a self avowed value investor.  However, he admitted that he did pay attention to some technical analysis to improve the timing of his value investing.  He discussed some of the technical investing tools which he used in his career in his book, Al Frank's New Prudent Speculator.  To him, the following summarized technical analysis:

When an equity issue - a common stock, preferred stock, or master limited partnership - trades, only one of three things can happen with its market price.  At that day's close each issue can have advanced, declined, or remained unchanged in price compared to its previous close (not necessarily the previous day)...Advancing-in-price issues represent buying - or at least more buying than selling at the moment - on the basic notion that an excess of buyers over sellers (or greater demand than supply) tends to bid up prices.  Conversely, selling is represented by stocks declining in price.  On any given day the fluctuations represented by buyers and sellers often appear to be random, as orders pour in from all over the world, some to trade "at the market" (the current asking price) or at a price limit with the trader hoping to to get a better deal than the current bid or ask price of a sale or a purchase.

Notice the gentle jab Frank takes at Random Walk proponents.

There is a book which is considered by many to be the bible of technical analysis; much like The Intelligent Investor by Benjamin Graham is widely seen as the bible of fundamental analysis.  Technical Analysis of Stock Trends was coauthored in 1948 by Robert D. Edwards and John Magee.  Its 8th and 9th editions, both edited by WHC Bassetti, are still in print today.  Some consider the following excerpt from the book to be the all time best description of technical analysis:

The market price reflects not only the differing fears and guesses and moods, rational and irrational, of hundreds of potential buyers and sellers, but it also reflects their needs and resources - in total, factors which defy analysis and for which no statistics are obtainable.  These are nevertheless all synthesized, weighted and finally expressed in the one precise figure at which a buyer and seller get together and make a deal.  The resulting price is the only figure that counts.*

If you look back at the advice of the value investors, you will see that, for the most part, they recommend investing for the long term.  It seems to me that, given the daily movement of the market, technical analysis looks at a shorter time horizon.  It appears to be more of a tool for speculation, looking for a profit within days, weeks or months - not an appreciating investment over several years.  We will continue to explore this strategy in further detail in upcoming blogs.

The material from Al Frank's New Prudent Speculator by Al Frank, copyright 1995 by Al Frank, is used with permission of the copyright holders, the heirs of Al Frank.

*Excerpt from Technical Analysis of Stock Trends, by Robert D. Edwards & John Magee, copyright 1948 by Robert D. Edwards & John Magee, page 5.

Comments are always welcome.