It's Not Prices; It's People - Some Final Words on Technical Analysis (1)

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We are now finished with our look at the technical aspects (the "how to") of technical analysis.  The thing that must be remembered is that charts and the technical indicators they reveal record market action, price and volume, which is nothing more that the collective actions of the investors and traders in the market.  Humphrey B. Neill explained it best in his 1931 classic Tape Reading & Market Tactics.  Neill described the true purpose of technical analysis or "tape reading" as he called it as follows:

In the first part of this book I have described the various kinds of people comprising the purchasers and sellers of stock.  The important point to remember here is that all of those people are human beings, just as you and I are.

Let us get that picture clearly in mind.  The ticker tape is simply a record of human nature passing in review.  It is a record giving us the opinions and hopes of thousands of people.  We must dismiss from our minds all other facts.*

Author's emphasis in bold. 

Technical analysis or charting in various forms has been around for scores of years.  It went by a different name back in Neill's day.  Back then technical analysts were referred to as "tape readers".  They received their market information from a ticker tape machine.  The ticker tape machine, which was connected to stock exchanges over telegraph wires, printed out narrow strips of paper with stock trades, including stock symbols, prices and volumes for all stock trades shortly after they happened on the floor of the stock exchange.  All of the brokerage firms and stock trading shops had the machines in order to keep up with the daily market action almost as it happened.  

The ticker tape machines provided stock trading reports on a delayed but close to real-time basis.  Use of ticker tapes phased out when television and computers took over the job of providing virtually instantaneous market action.  The streaming electronic boards with stock symbols, prices and volumes on financial television broadcasts and in brokers' offices have replaced the old paper tape.  The narrow strips of tape served a second purpose.  They were used as confetti and thrown out office windows during parades on New York City streets.  Hence the term "ticker tape" parades.

The hey day of the tape reader occurred in the early 1900s when stock market manipulation (referred to then as "operations") by secret investor pools and groups of corporate insiders  was rampant.  Back then the strategy was one of quiet accumulation and managed distribution of large amounts of a target stock.  These days such an operation might be called a "pump and dump."  It was only after the crash of 1929 and the establishment of the Securities & Exchange Commission ("SEC") in America that such activities were banned in this country.  Whether such illegal activities continue today, despite the prohibition, is a topic for another day.

As the tape was received, the tape reader looked for price and volume movements which signaled that a stock market "operation" might be under way.  The insightful trader would try to interpret what "they" were doing and buy the target stock to profit from the manipulated run up of a stock's price.  The trader hoped to sell out his or her position before the inevitable crash of the stock when the group had unloaded all of their holdings on an unsuspecting public attracted to the stock by its market action.  As I indicated above, it's really all about the people in the market.

Like most stock market strategies, the popularity of technical analysis waxes and wanes.  In his book, Rediscovering the Wheel: Contrary Thinking & Investment Strategy, Bradbury K. Thurlow, a Wall Street broker and author, looked at the history of technical analysis:

Forecasting techniques in this field move through distinct life cycles.  If rationally conceived, as technical analysis certainly was, they achieve success before they are recognized, they achieve more success as skepticism increasingly questions their validity, the success becomes spectacular as skepticism is destroyed and replaced by universal belief.  Then they begin to fail.  People then achieve success by going directly contrary to the recognized technique, a period of anarchy ensues in which the technique and the anti-technique neutralize one another.  It is at this stage that Mr. Malkiel's random behavior is most clearly observed.  The technique is then discredited and gradually falls into disuse.**

To paraphrase the oft cited biblical quote, "To every investment strategy, there is a season."  Technical analysis was popular again in the 1960s and once again fell out of favor after the stock market crash of the early 1970s.  Given all of today's advertising by on-line brokers about their electronic trading platforms, it would seem that following charts may be in vogue yet again. We will conclude our discussion of technical analysis in the next blog.

*Excerpt from Tape Reading & Market Tactics, Humphrey B. Neill, republished by BN Publishing, pages 32-33


** Excerpt from Rediscovering the Wheel: Contrary Thinking & Investment Strategy by Bradbury K. Thurlow, Fraser Publishing Company, copyright 1981, page 116


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