WALL STREET SMARTS, THE BLOG, IS NOW WALL STREET SMARTS, THE BOOK. FULLY EDITED AND REVISED WITH NEW MATERIAL ON AMAZON
We have now completed our studies of fundamental and technical analysis. The practitioners of each form of investing mock and belittle the other. Random walkers, like Professor Malkiel, criticize both of them for various perceived shortcomings. Bradbury K. Thurlow in his work, Rediscovering the Wheel, Contrary Thinking & Investment Strategy, did a very good job of laying out the differences between these three investment philosophies as follows:
A majority of both professional security analysts and individual investors would support the thesis that careful fundamental analysis (i.e. of a company's earnings record and outlook) is prerequisite to any responsible investment decision.
The antithesis, believed by technical analysts for many years, is that the price of a stock at any given moment discounts all known relevant information and that first-hand knowledge of same is redundant in the decision making process.
According to academic Efficient Market Theory (more respectable that Granville's thought, but related to it) pertinent knowledge is discounted in the price structure before anyone can legally profit from it.*
It may be presumptuous on my part, given my lack of expertise when compared to these eminent financial writers, but I would suggest that fundamental and technical analysis may each have a place in an investor's arsenal. An investor's personality will, undoubtedly, tend to bias his or her choice toward one or the other of the two strategies. A person with a deliberate bent for accounting factors might not be attracted to the "quick draw" nature of short term, technical trading moves. Conversely, a person looking for quick "in and out" trading in the market will find a long-term fundamental approach utterly dull and smothering. So, to a certain extent, an individual's personality will probably lead him or her to either fundamental or technical ways of investing.
Notwithstanding the psychological attractions of each form of investing, all investors in the market share a common goal: making a profit. The follow-on to that common goal could be, however, the time it takes to book the profit. Viewed from this perspective, the issue of which form of investment strategy is better might be recast as an exploration of an investor's goals and time horizons for the money available at the time. If a 30 year old, busy furthering his or her career, is investing for retirement and has little time or inclination to devote to the task, then a fundamental "buy it for keeps" approach may make the most sense. Finding a small portfolio of companies which meet all of his or her requirements for value investments may be all that is needed at this point in the person's professional/investing life. That may change in the future, but for now such a strategy fits the bill.
At some other point in time and with funds to be devoted to a different investment goal, the same person, seeking a profit in a number of days, weeks or months as opposed retirement funds needed several years hence, may find a short term technical strategy attractive. Please note the qualifier in that last sentence, "with funds to be devoted to a different investment goal." The money put into long-term, fundamental value investments for retirement is not disturbed. Different investment funds, which the person can afford to lose without suffering lasting financial damage, could be devoted to short term, technical trades.
Yes, it may be possible to have it both ways. The danger lies in the fact that it is difficult enough to master one, much less, two strategies. The level of difficulty increases, probably logarithmically, in attempting to learn a second set of rules and strategies. More to the point, funds initially invested with a long term goal should be left untouched and not be converted and used for short term trading gains. With that caveat in mind, an individual is free to step up and take a shot.
* Excerpt from Rediscovering the Wheel: Contrary Thinking & Investment Strategy by Bradbury K. Thurlow, Fraser Publishing Company, copyright 1981, page103
Comments are always welcome.
Monday, February 27, 2012
Monday, February 20, 2012
It's Not Prices; It's People - Some Final Words on Technical Analysis (2)
WALL STREET SMARTS, THE BLOG, IS NOW WALL STREET SMARTS, THE BOOK. FULLY EDITED AND REVISED WITH NEW MATERIAL ON AMAZON
As I wrote in the last blog, market action is really people action.
In his book, A Random Walk Down Wall Street, Professor Malkiel summed up technical analysis as follows:
Most chartists believe that the market is only 10 percent logical and 90 percent psychological. They generally subscribe to the castle-in-the-air school and view the investment game as one of anticipating how the other players will behave. Charts, of course, tell only what the other players have been doing in the past. The chartist's hope, however, is that a careful study of what the other players are doing will shed light on what the crowd is likely to do in the future.*
Conversely, he felt that fundamental analysts believe the market to be 90 percent logical and 10 percent psychological (or emotional). It is interesting that Professor Malkiel refers to the stock market as "the investment game" and to the people trading and investing in it as "players." With a nod to Gustave Le Bon, he also refers to them as "the crowd."
In the book, The Money Game, the author, writing under the pseudonym Adam Smith, marveled at the fact that the very famous and controversial economist, John Maynard Keynes, also referred to investing as a game. While teaching economics at Cambridge, Keynes successfully invested for himself and the school, supposedly only devoting half an hour a day to the task. In his famous economic text, The General Theory of Employment, Interest and Money published in 1936, Professor Keynes described investing in a number of ways, all based on the idea that the successful investor is one who outwits the crowd. He likened investing to party games:
This battle of wits to anticipate the basis of conventional valuation a few months hence, rather than the prospective yield of an investment over a long term of years does not even require gulls amongst the public to feed the maws of the professional;--it can be played by professionals amongst themselves.....For it is, so to speak, a game of Snap, of Old Maid, of Musical Chairs--a pastime in which he is victor who says Snap neither too soon nor too late, who passes the Old Maid to his neighbor before the game is over, who secures a chair for himself when the music stops.**
Keynes went on to compare investing with a popular newspaper contest of his time. The object of the competition was to pick out the prettiest faces from hundreds of photographs with the prize going to the contestant who picked the faces also preferred by the entrants as a group. As Professor Keynes pointed out, the person picking the six prettiest had to decide which faces the group at large would choose when each of them is competing in the same way. He described the problem as follows:
It is not a case of choosing those which, to the best of one's judgment, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligence to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practice the fourth, fifth and higher degrees.**
This is the essence of technical analysis. Indeed, the goal of technical analysis is learning from charts what the people in the market have been doing previously (maybe just yesterday) with an eye to anticipating their next moves. The chartist's strategy is to take a trading position in a stock which appears most likely to either increase or decrease in price, thereby netting a profit ahead of the investing crowd. Yes, it is possible to make money on a stock in decline; what is called "shorting" a stock. This is a trading tactic we will explore in greater detail in a future blog. We will also discuss two of technical analysis' offspring in the future: market timing and momentum trading. However, we have finished our exploration of this trading strategy for now.
* The material from A Random Walk Down Wall Street by Burton G. Malkiel, copyright 1999, 1996, 1990, 1985, 1981, 1975, 1973 by W.W. Norton & Company, Inc. is used with permission of W.W. Norton & Company, Inc.
** Excerpts from The General Theory of Employment, Interest and Money, John Maynard Keynes, copyright 1936, republished in the Great Minds Series by Prometheus Books 1997, pages 155-156
Comments are always welcome.
As I wrote in the last blog, market action is really people action.
In his book, A Random Walk Down Wall Street, Professor Malkiel summed up technical analysis as follows:
Most chartists believe that the market is only 10 percent logical and 90 percent psychological. They generally subscribe to the castle-in-the-air school and view the investment game as one of anticipating how the other players will behave. Charts, of course, tell only what the other players have been doing in the past. The chartist's hope, however, is that a careful study of what the other players are doing will shed light on what the crowd is likely to do in the future.*
Conversely, he felt that fundamental analysts believe the market to be 90 percent logical and 10 percent psychological (or emotional). It is interesting that Professor Malkiel refers to the stock market as "the investment game" and to the people trading and investing in it as "players." With a nod to Gustave Le Bon, he also refers to them as "the crowd."
In the book, The Money Game, the author, writing under the pseudonym Adam Smith, marveled at the fact that the very famous and controversial economist, John Maynard Keynes, also referred to investing as a game. While teaching economics at Cambridge, Keynes successfully invested for himself and the school, supposedly only devoting half an hour a day to the task. In his famous economic text, The General Theory of Employment, Interest and Money published in 1936, Professor Keynes described investing in a number of ways, all based on the idea that the successful investor is one who outwits the crowd. He likened investing to party games:
This battle of wits to anticipate the basis of conventional valuation a few months hence, rather than the prospective yield of an investment over a long term of years does not even require gulls amongst the public to feed the maws of the professional;--it can be played by professionals amongst themselves.....For it is, so to speak, a game of Snap, of Old Maid, of Musical Chairs--a pastime in which he is victor who says Snap neither too soon nor too late, who passes the Old Maid to his neighbor before the game is over, who secures a chair for himself when the music stops.**
Keynes went on to compare investing with a popular newspaper contest of his time. The object of the competition was to pick out the prettiest faces from hundreds of photographs with the prize going to the contestant who picked the faces also preferred by the entrants as a group. As Professor Keynes pointed out, the person picking the six prettiest had to decide which faces the group at large would choose when each of them is competing in the same way. He described the problem as follows:
It is not a case of choosing those which, to the best of one's judgment, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligence to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practice the fourth, fifth and higher degrees.**
This is the essence of technical analysis. Indeed, the goal of technical analysis is learning from charts what the people in the market have been doing previously (maybe just yesterday) with an eye to anticipating their next moves. The chartist's strategy is to take a trading position in a stock which appears most likely to either increase or decrease in price, thereby netting a profit ahead of the investing crowd. Yes, it is possible to make money on a stock in decline; what is called "shorting" a stock. This is a trading tactic we will explore in greater detail in a future blog. We will also discuss two of technical analysis' offspring in the future: market timing and momentum trading. However, we have finished our exploration of this trading strategy for now.
* The material from A Random Walk Down Wall Street by Burton G. Malkiel, copyright 1999, 1996, 1990, 1985, 1981, 1975, 1973 by W.W. Norton & Company, Inc. is used with permission of W.W. Norton & Company, Inc.
** Excerpts from The General Theory of Employment, Interest and Money, John Maynard Keynes, copyright 1936, republished in the Great Minds Series by Prometheus Books 1997, pages 155-156
Comments are always welcome.
Monday, February 13, 2012
It's Not Prices; It's People - Some Final Words on Technical Analysis (1)
WALL STREET SMARTS, THE BLOG, IS NOW WALL STREET SMARTS, THE BOOK. FULLY EDITED AND REVISED WITH NEW MATERIAL ON AMAZON
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
Comments are always welcome.
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
Comments are always welcome.
Monday, February 6, 2012
Making A Chart
WALL STREET SMARTS, THE BLOG, IS NOW WALL STREET SMARTS, THE BOOK. FULLY EDITED AND REVISED WITH NEW MATERIAL ON AMAZON
If a person has an interest in technical analysis, it would seem logical that the individual would want to start studying charts. There are two ways to do that: seek advice or do it yourself. The person looking for advice could subscribe to a technical analyst's newsletter and follow the author's recommendations. The goal then becomes finding the newsletter that resonates with the individual with the hope of making at least enough money to pay the subscription fee. The do-it-yourself type must start by making a chart of the stock or the market in which he or she is interested. Whether it is a bar chart, a point and figure chart, a candlestick chart or one of the many other types available, picking the form of chart is the first decision that must be made. The type of chart to use is a personal decision, much like the financial metrics selected by a fundamental analyst for his or her stock screen.
The computer has made charting a lot easier. The computer literate chartist has several free stock chart websites from which to choose. Some of the top sites include StockCharts.com, Yahoo Finance and Bigcharts.com. Google Finance also provides technical charting, but it is a little more difficult to navigate the site. This link to YouTube will explain how to use the technical tools at Google Finance. It is a clunky video without sound, but you should be able follow the steps shown to get to Google charts on the particular stocks you want to follow.
The old fashion way of charting involved pencil and graph paper with daily notations of the price movements of the chosen stock or market. Justin Mamis in his book, The Nature of Risk, Stock Market Survival & The Meaning of Life, had the following to say about making charts:
You may not believe this, or want to accept it in this computerized era, but once you start keeping even a handful of charts yourself you'll see (and feel) the difference. The very nature of how the stock is behaving rises to the surface via your pencil's posting the volume and the pattern. Of course, it's not perfect; it isn't even close to perfect. Sort of like Churchill's backhanded compliment about capitalism, it's just better than anything else, and certainly better than nothing. What happens is that the market "talks" to you as the language of its ticks becomes recordable on your chart paper. Keeping your own charts is the way the market's language can be heard most directly. To paraphrase a more important statement: All the rest of technical analysis is commentary.*
Author's emphasis in bold.
Mr. Mamis repeated his advice about keeping your own chart in his later book, When To Sell, Inside Strategies for Stock Market Profits. Reminding his readers that charting did not take all that much time out of their day, he wrote:
It's taken you far longer to read this than it will to keep up with these statistics each day. We repeat: Don't rely on someone else to do what will take you so little time. You'll find you get a much better feel for what is actually happening by keeping your own hand and mind in.**
Regardless of which type of chart the individual decides to use, the goal remains the same: see what is happening with a stock or a market and then decide how to turn that information into a profit. We will continue our study of technical analysis in the next blog.
* Excerpt from The Nature of Risk, Stock Market Survival and the Meaning of Life by Justin Mamis, copyright 1991, page 221
** Excerpt from When To Sell, Inside Strategies for Stock Market Profits by Justin Mamis, copyright 1994, is used with the permission of Mr. Mamis and Fraser Publishing Company
Comments are always welcome.
If a person has an interest in technical analysis, it would seem logical that the individual would want to start studying charts. There are two ways to do that: seek advice or do it yourself. The person looking for advice could subscribe to a technical analyst's newsletter and follow the author's recommendations. The goal then becomes finding the newsletter that resonates with the individual with the hope of making at least enough money to pay the subscription fee. The do-it-yourself type must start by making a chart of the stock or the market in which he or she is interested. Whether it is a bar chart, a point and figure chart, a candlestick chart or one of the many other types available, picking the form of chart is the first decision that must be made. The type of chart to use is a personal decision, much like the financial metrics selected by a fundamental analyst for his or her stock screen.
The computer has made charting a lot easier. The computer literate chartist has several free stock chart websites from which to choose. Some of the top sites include StockCharts.com, Yahoo Finance and Bigcharts.com. Google Finance also provides technical charting, but it is a little more difficult to navigate the site. This link to YouTube will explain how to use the technical tools at Google Finance. It is a clunky video without sound, but you should be able follow the steps shown to get to Google charts on the particular stocks you want to follow.
The old fashion way of charting involved pencil and graph paper with daily notations of the price movements of the chosen stock or market. Justin Mamis in his book, The Nature of Risk, Stock Market Survival & The Meaning of Life, had the following to say about making charts:
You may not believe this, or want to accept it in this computerized era, but once you start keeping even a handful of charts yourself you'll see (and feel) the difference. The very nature of how the stock is behaving rises to the surface via your pencil's posting the volume and the pattern. Of course, it's not perfect; it isn't even close to perfect. Sort of like Churchill's backhanded compliment about capitalism, it's just better than anything else, and certainly better than nothing. What happens is that the market "talks" to you as the language of its ticks becomes recordable on your chart paper. Keeping your own charts is the way the market's language can be heard most directly. To paraphrase a more important statement: All the rest of technical analysis is commentary.*
Author's emphasis in bold.
Mr. Mamis repeated his advice about keeping your own chart in his later book, When To Sell, Inside Strategies for Stock Market Profits. Reminding his readers that charting did not take all that much time out of their day, he wrote:
It's taken you far longer to read this than it will to keep up with these statistics each day. We repeat: Don't rely on someone else to do what will take you so little time. You'll find you get a much better feel for what is actually happening by keeping your own hand and mind in.**
Regardless of which type of chart the individual decides to use, the goal remains the same: see what is happening with a stock or a market and then decide how to turn that information into a profit. We will continue our study of technical analysis in the next blog.
* Excerpt from The Nature of Risk, Stock Market Survival and the Meaning of Life by Justin Mamis, copyright 1991, page 221
** Excerpt from When To Sell, Inside Strategies for Stock Market Profits by Justin Mamis, copyright 1994, is used with the permission of Mr. Mamis and Fraser Publishing Company
Comments are always welcome.
Monday, January 30, 2012
Charting a Course (3)
WALL STREET SMARTS, THE BLOG, IS NOW WALL STREET SMARTS, THE BOOK. FULLY EDITED AND REVISED WITH NEW MATERIAL ON AMAZON
In the last blog, we talked about a stock's "price range", the band within which recent prices are trading. If this band continues for a period of time, technical analysts refer to this as consolidation. During a period of consolidation, buyers and sellers seem to be indecisive as to which way the stock is going to move in the future, either up or down, since the trend line is flat. The stable price range might last for days, weeks or months. During this period of neutrality, chartists look for indicators as to which way (up or down) the stock price might break out of the consolidation, which would signal the next trend.
If the trend is going to resume the past direction, technical analysts believe the chart will show a pattern which looks like either a flag or a pennant. A flag forms a rectangle of prices, usually with a slope in the opposite direction from the previous rise or decline. A pennant is a triangular band, starting with wide price swings and converging at a point of small price changes, with no apparent directional slope. Each of these indicators tells the chartist that the stock is taking a break before continuing to resume the previous price direction. This link to the website StockCharts.com provides additional explanation and examples of flags and pennants. If the flags and pennants persist over a long period of time, the chartist may view the flag as a rectangle and the pennant as a symmetrical triangle, two other indicators.
If the trend is going to reverse itself and head in the opposite direction (a point of inflection), the chart might show a price pattern over time which looks like, first, a left shoulder, then a head and, finally, a right shoulder: the head and shoulders pattern with alternating price rises and declines of varying heights and lengths.
A head and shoulders indicator, viewed in the normal pattern, is seen as a reversal from a trend of increasing prices to a trend of declining prices following the final movement of the right shoulder (downward). This link to the website StockCharts.com provides additional explanation and an example of the top (reversal) head and shoulders indicator.
A reverse head and shoulders indicator, which looks the same, but upside down, is viewed as the reversal from a trend of declining prices to a trend of increasing prices, following, again, the final movement of the right shoulder (upward). This link to the website StockCharts.com provides additional explanation and an example of the bottom (reversal) head and shoulders indicator.
These are but a few of the more widely studied indicators used by chartists. In the next blog, we will continue our study of charts and technical analysis.
As always, comments are welcome.
In the last blog, we talked about a stock's "price range", the band within which recent prices are trading. If this band continues for a period of time, technical analysts refer to this as consolidation. During a period of consolidation, buyers and sellers seem to be indecisive as to which way the stock is going to move in the future, either up or down, since the trend line is flat. The stable price range might last for days, weeks or months. During this period of neutrality, chartists look for indicators as to which way (up or down) the stock price might break out of the consolidation, which would signal the next trend.
If the trend is going to resume the past direction, technical analysts believe the chart will show a pattern which looks like either a flag or a pennant. A flag forms a rectangle of prices, usually with a slope in the opposite direction from the previous rise or decline. A pennant is a triangular band, starting with wide price swings and converging at a point of small price changes, with no apparent directional slope. Each of these indicators tells the chartist that the stock is taking a break before continuing to resume the previous price direction. This link to the website StockCharts.com provides additional explanation and examples of flags and pennants. If the flags and pennants persist over a long period of time, the chartist may view the flag as a rectangle and the pennant as a symmetrical triangle, two other indicators.
If the trend is going to reverse itself and head in the opposite direction (a point of inflection), the chart might show a price pattern over time which looks like, first, a left shoulder, then a head and, finally, a right shoulder: the head and shoulders pattern with alternating price rises and declines of varying heights and lengths.
A head and shoulders indicator, viewed in the normal pattern, is seen as a reversal from a trend of increasing prices to a trend of declining prices following the final movement of the right shoulder (downward). This link to the website StockCharts.com provides additional explanation and an example of the top (reversal) head and shoulders indicator.
A reverse head and shoulders indicator, which looks the same, but upside down, is viewed as the reversal from a trend of declining prices to a trend of increasing prices, following, again, the final movement of the right shoulder (upward). This link to the website StockCharts.com provides additional explanation and an example of the bottom (reversal) head and shoulders indicator.
These are but a few of the more widely studied indicators used by chartists. In the next blog, we will continue our study of charts and technical analysis.
As always, comments are welcome.
Monday, January 23, 2012
Charting a Course (2)
WALL STREET SMARTS, THE BLOG, IS NOW WALL STREET SMARTS, THE BOOK. FULLY EDITED AND REVISED WITH NEW MATERIAL ON AMAZON
Assuming that the technical analyst has been studying his or her chart of choice for a period of time and patterns are beginning to reveal themselves, the question is what is being shown? In his book, Stock Market Logic, A Sophisticated Approach to Profits on Wall Street, Norman G. Fosback discusses chart patterns as follows:
Because there is a potentially infinite number of price patterns that a stock can trace, chartists have identified (devised) a virtually infinite number of chart patterns to correspond to them. These patterns are known by such esoteric names as head and shoulders, reverse head and shoulders, single, double, and triple tops and bottoms, flags, pennants, spikes, saucers, triangles, rectangles, lines, breakouts, consolidations, blowoffs; in short a name for everything and everything with a name.*
This blog is not intended to provide an in-depth study of charting. Given the large number of patterns studied by technical analysts, I will discuss only a few of the more well known patterns or indicators. A chart covering a long period of price movement for an individual stock will begin to show trends, up, down or sideways. If the time period shown on the chart is short term, the movements can be quite jagged. As the time period lengthens, the chartist can trace a trend line along the price increases or declines shown on the chart. The trend line (starting from the left) over time is either pointing northeast (going up); southeast (going down); due east (staying the same) or reversing itself (inflection point). These are the most basic messages a chart can provide.
Over time, relatively consistent highs and lows begin to show a stock's "price range" which is defined by what is called the Support Level on the bottom, the lowest point beyond which the price has not dropped in the applicable time period, and the Resistance Level on the top, the highest point beyond which the price has not risen in the same period. This is the band within which the stock is traded. The chartist believes that a price break out above or below the "price range" is very predictive of where the price might go in future trading. In effect, the market may be in the process of setting new Support or Resistance Levels. One of the basic principles of technical analysis is that a price break out either above the Resistance Level or below the Support Level or the occurrence of a sustained inflection point when the trend line reverses itself are all very important indicators. Depending on the volume accompanying such moves, the chart could be providing a strong indicator for the technical analyst to consider.
We should remember that the prices being charted show purchases and sales by people in the market. The Support Level reflects the price at which buyers have consistently come into the market to purchase shares of the stock. This would appear to be the price level at which the market considers the stock so cheap that it is a buy no matter what. Conversely, Resistance Levels reflect the price above which no one is buying the stock, the price level at which the market considers the stock too expensive to buy no matter what. Any changes in these levels could be seen as changes in investor/trader sentiment about a stock. Technical analysts see this as a foreshadowing of what people in the market may do in upcoming days, which could give the chartist a trading advantage.
We will study some additional common patterns or indicators in the next blog.
* Excerpt from Stock Market Logic, A Sophisticated Approach to Profits on Wall Street, Norman G. Fosback, copyright 1976, 1993, The Institute for Econometric Research, pages 212-213
Comments are always welcome.
Assuming that the technical analyst has been studying his or her chart of choice for a period of time and patterns are beginning to reveal themselves, the question is what is being shown? In his book, Stock Market Logic, A Sophisticated Approach to Profits on Wall Street, Norman G. Fosback discusses chart patterns as follows:
Because there is a potentially infinite number of price patterns that a stock can trace, chartists have identified (devised) a virtually infinite number of chart patterns to correspond to them. These patterns are known by such esoteric names as head and shoulders, reverse head and shoulders, single, double, and triple tops and bottoms, flags, pennants, spikes, saucers, triangles, rectangles, lines, breakouts, consolidations, blowoffs; in short a name for everything and everything with a name.*
This blog is not intended to provide an in-depth study of charting. Given the large number of patterns studied by technical analysts, I will discuss only a few of the more well known patterns or indicators. A chart covering a long period of price movement for an individual stock will begin to show trends, up, down or sideways. If the time period shown on the chart is short term, the movements can be quite jagged. As the time period lengthens, the chartist can trace a trend line along the price increases or declines shown on the chart. The trend line (starting from the left) over time is either pointing northeast (going up); southeast (going down); due east (staying the same) or reversing itself (inflection point). These are the most basic messages a chart can provide.
Over time, relatively consistent highs and lows begin to show a stock's "price range" which is defined by what is called the Support Level on the bottom, the lowest point beyond which the price has not dropped in the applicable time period, and the Resistance Level on the top, the highest point beyond which the price has not risen in the same period. This is the band within which the stock is traded. The chartist believes that a price break out above or below the "price range" is very predictive of where the price might go in future trading. In effect, the market may be in the process of setting new Support or Resistance Levels. One of the basic principles of technical analysis is that a price break out either above the Resistance Level or below the Support Level or the occurrence of a sustained inflection point when the trend line reverses itself are all very important indicators. Depending on the volume accompanying such moves, the chart could be providing a strong indicator for the technical analyst to consider.
We should remember that the prices being charted show purchases and sales by people in the market. The Support Level reflects the price at which buyers have consistently come into the market to purchase shares of the stock. This would appear to be the price level at which the market considers the stock so cheap that it is a buy no matter what. Conversely, Resistance Levels reflect the price above which no one is buying the stock, the price level at which the market considers the stock too expensive to buy no matter what. Any changes in these levels could be seen as changes in investor/trader sentiment about a stock. Technical analysts see this as a foreshadowing of what people in the market may do in upcoming days, which could give the chartist a trading advantage.
We will study some additional common patterns or indicators in the next blog.
* Excerpt from Stock Market Logic, A Sophisticated Approach to Profits on Wall Street, Norman G. Fosback, copyright 1976, 1993, The Institute for Econometric Research, pages 212-213
Comments are always welcome.
Monday, January 16, 2012
Charting A Course (1)
WALL STREET SMARTS, THE BLOG, IS NOW WALL STREET SMARTS, THE BOOK. FULLY EDITED AND REVISED WITH NEW MATERIAL ON AMAZON
We have used the term, "chartist" in past blogs as another term for technical analyst. There are as many types of charts as there are chartists. The form of chart used is a personal decision which, I suspect, is dictated by the type of information the technical analyst believes is important and predictive. The chartist wants the information presented in a fashion with which he or she feels most comfortable. There are two forms of chart used by many in the technical community: the bar chart and the point and figure chart. First, we will learn about the bar chart ("BC").
The BC gives the analyst a picture of price movement over time. The individual making this type of chart notes the price points along the vertical axis and the discrete time periods along the horizontal axis. The vertical line or bar within the graph shows the price movement for the selected time - a day, a week, a month or any other time period the chartist wants to work with. For our example, we'll use a daily bar. The top of the bar is the highest price of the stock that day. The bottom of the bar, conversely, is the lowest price of that day. The closing price within that price spread is noted with a horizontal hash or tick line across the vertical bar. Creating a BC of daily prices takes time and patience because a few days of bars will not reveal much more than daily randomness, i.e., market noise, so to speak.
As we learned in the last blog, volume plays an important role in providing a complete picture. Many BC graphs will also indicate the volume for the selected time period. In our example, the daily volume (again as a vertical line) would be drawn at the bottom of the chart below the price bar for each day. This is really a graph within a graph since the left side of the graph below the price axis must also show volume numbers. If a stock trades several thousand shares a day, the volume points can be set in thousands. If it trades only a few hundred shares daily, then the volume axis points can be set in hundreds. The goal in our example is to show the ebb and flow of both the stock's price movement and trading volume for each day.
I must apologize for the rather tortured two paragraphs above. It is very difficult to describe a graph in words. This link to the website EHow.com will provide a short video about the BC, the most popular form of graphing.
The second most popular graph is the point and figure chart ("PF"). The main difference between the BC and the PF chart forms is the fact that time is not an element in PF charts. The focus is solely on price movement, up or down. A sheet of graph paper is a page of boxes. The PF chartist designates a dollar value for each square on the graph: $1, $5, or any dollar amount the he or she decides to use. The vertical axis on a PF chart lists prices. The horizontal axis on a PF chart does not have a value measure. So long as the price of a stock is advancing, the rise in price is indicated by X's (each X representing the designated dollar box value) added in the same column. When the price goes into decline, the chartist moves to the next column to the right and notes the decline(s) with one or more O's starting at the first declining price point (again based on the dollar value of each box). Additional O's are added in that same column, so long as the price continues to decline.
Let me provide an example. If the dollar value of each box is $3 and the price has risen $15, then the chartist marks 5 boxes in a column matched to the prices shown on the vertical axis of the graph. Each time the price goes up another $3, another X is added to the same column, keeping pace with the prices noted on the left axis. If the chartist has decided that a reversal will not be graphed unless it exceeds $6, then the X's continue to be added (at $3 per X) until the price reverses by $6 or more. At that point, the chartist starts marking O's in the next column to the right (starting at the first declining price level) and continues to show price declines in that column (in $3 increments) until a reversal to the upside of $6 or more occurs.
Time does not play a role in the PF chart. Price movement is the only thing that matters. The X's or O's continue to be added to the same column until the price reverses. In order to avoid small daily fluctuations, which would result in an unwieldy chart, the chartist may decide not to show a reversal unless the price has either risen or declined by a set amount, such as $6 or more as in my example above. This number would be picked by the analyst based on the stock's average daily volatility. I am not a chartist, but it seems to me that a second graph sheet supplementing the PF chart showing trading volume would be helpful. I have no idea how such a chart would be set up, but since volume is considered such an important factor in technical analysis, you would think a PF chartist would want to keep track of it.
Again, I apologize for this rather dense text. A clearer presentation, with an example, can be seen with this link to the website Stockcharts.com.
We will continue exploring charts in the next blog.
Comments are always welcome.
We have used the term, "chartist" in past blogs as another term for technical analyst. There are as many types of charts as there are chartists. The form of chart used is a personal decision which, I suspect, is dictated by the type of information the technical analyst believes is important and predictive. The chartist wants the information presented in a fashion with which he or she feels most comfortable. There are two forms of chart used by many in the technical community: the bar chart and the point and figure chart. First, we will learn about the bar chart ("BC").
The BC gives the analyst a picture of price movement over time. The individual making this type of chart notes the price points along the vertical axis and the discrete time periods along the horizontal axis. The vertical line or bar within the graph shows the price movement for the selected time - a day, a week, a month or any other time period the chartist wants to work with. For our example, we'll use a daily bar. The top of the bar is the highest price of the stock that day. The bottom of the bar, conversely, is the lowest price of that day. The closing price within that price spread is noted with a horizontal hash or tick line across the vertical bar. Creating a BC of daily prices takes time and patience because a few days of bars will not reveal much more than daily randomness, i.e., market noise, so to speak.
As we learned in the last blog, volume plays an important role in providing a complete picture. Many BC graphs will also indicate the volume for the selected time period. In our example, the daily volume (again as a vertical line) would be drawn at the bottom of the chart below the price bar for each day. This is really a graph within a graph since the left side of the graph below the price axis must also show volume numbers. If a stock trades several thousand shares a day, the volume points can be set in thousands. If it trades only a few hundred shares daily, then the volume axis points can be set in hundreds. The goal in our example is to show the ebb and flow of both the stock's price movement and trading volume for each day.
I must apologize for the rather tortured two paragraphs above. It is very difficult to describe a graph in words. This link to the website EHow.com will provide a short video about the BC, the most popular form of graphing.
The second most popular graph is the point and figure chart ("PF"). The main difference between the BC and the PF chart forms is the fact that time is not an element in PF charts. The focus is solely on price movement, up or down. A sheet of graph paper is a page of boxes. The PF chartist designates a dollar value for each square on the graph: $1, $5, or any dollar amount the he or she decides to use. The vertical axis on a PF chart lists prices. The horizontal axis on a PF chart does not have a value measure. So long as the price of a stock is advancing, the rise in price is indicated by X's (each X representing the designated dollar box value) added in the same column. When the price goes into decline, the chartist moves to the next column to the right and notes the decline(s) with one or more O's starting at the first declining price point (again based on the dollar value of each box). Additional O's are added in that same column, so long as the price continues to decline.
Let me provide an example. If the dollar value of each box is $3 and the price has risen $15, then the chartist marks 5 boxes in a column matched to the prices shown on the vertical axis of the graph. Each time the price goes up another $3, another X is added to the same column, keeping pace with the prices noted on the left axis. If the chartist has decided that a reversal will not be graphed unless it exceeds $6, then the X's continue to be added (at $3 per X) until the price reverses by $6 or more. At that point, the chartist starts marking O's in the next column to the right (starting at the first declining price level) and continues to show price declines in that column (in $3 increments) until a reversal to the upside of $6 or more occurs.
Time does not play a role in the PF chart. Price movement is the only thing that matters. The X's or O's continue to be added to the same column until the price reverses. In order to avoid small daily fluctuations, which would result in an unwieldy chart, the chartist may decide not to show a reversal unless the price has either risen or declined by a set amount, such as $6 or more as in my example above. This number would be picked by the analyst based on the stock's average daily volatility. I am not a chartist, but it seems to me that a second graph sheet supplementing the PF chart showing trading volume would be helpful. I have no idea how such a chart would be set up, but since volume is considered such an important factor in technical analysis, you would think a PF chartist would want to keep track of it.
Again, I apologize for this rather dense text. A clearer presentation, with an example, can be seen with this link to the website Stockcharts.com.
We will continue exploring charts in the next blog.
Comments are always welcome.
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