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Today's WrapUp by Martin Goldberg 10.16.2003 Mon Tue Wed Thu Fri Archive |
Technical Analysis -- Valuable Tool or Misguided Product of 'Beautiful Mind'?
Recommendations for Self-Teaching Technical Analysis
In the movie, “A Beautiful Mind”, university professor, John Forbes Nash Jr., suffers from schizophrenia and hallucinates that he has been engaged by the CIA to decode a foreign plot to overthrow the US Government. He looks for clues to these plots through what he believes are messages he finds in common magazines and newspapers. His hallucinations are so detailed and real in his mind that he sees and talks to an imaginary CIA agent, Parcher, played by Ed Harris.
Professor Nash’s wife discovers her husband’s schizophrenia in a chilling scene where she finds his work shop/garage walls pasted with the obviously imagined magazine “messages”. This is where her husband spent many hours working privately.
In many respects the public perceives technical analysts to be similar to Dr. Nash. As with Dr. Nash in “Beautiful Mind”, the public perceives technical analysts as borderline schizophrenics looking for order in random occurrences in stock market charts. Perhaps their own failures in their attempts to read stock charts lend more credence to their belief that technical analysts are practicing useless voodoo, or readings of an 8-ball, or ouija board. They get a lot of reinforcement from some writers in financial magazine publications, and cable TV. Cable often includes brief “bites” of so-called technical experts espousing analyses that are as unsound as their cheerleading analysts’ misguided stock tips.
Here is an email quote from an old friend following his review of my first Financial Sense article (it's rumored he lost big in this bear market):
“If you tend to over analyze things, you eventually will see a trend line in totally random things”
The facts are that there is something of value in technical analysis. Human nature tends to take on repeatable patterns. Such patterns are represented on stock charts, which can be used to predict future stock moves. However, technical analysis is a discipline that is similar to counting cards at the blackjack table. You will not make money every time. Appropriate use of technical analysis will give you an edge over the market or “house” that will allow you to make money over time (including transaction costs). There are many styles and philosophies of technical analysis. The beginner should know that as with anything else of value, it requires a lot of work including education, practice, and discipline. It’s amazing how many people trade stocks based on what they think is sound technical analysis, having never even read a book or examined anything except for Internet stock message boards. That is a sure fire method for failure. Internet Chat boards are loaded with misguided hearsay posing for technical analysis. It’s a waste of time. Stay away.
Our stock market is in the midst of a speculative bubble. I agree with Warren Buffett’s observation this winter (when the stock market was much lower), that there is very little true investment value in most sectors of common stocks of US companies now. This winter, Buffett’s organization ferreted out Best Buy (BBY), stock in the low 20’s. It was sold a couple of months ago in the mid-40s, and now trades in the mid-50s. No longer a Buffett-type value by any means! There is precious little profit to be made in investing in common stocks in the fundamental buy-and-hold manner that made Warren Buffett one of the best long-term investors and richest people in the world. If you read any good book on fundamental analysis of stocks written in the 80s or before, you will find that the valuations used as examples are much lower from what we have in today’s market. If you want to be like Warren Buffett, you will have to wait for this current speculative bubble to burst. Be patient, eventually it will. In this stock market environment, to achieve positive returns while avoiding large losses you must know and apply technical analysis. To do this effectively, you must educate yourself.
Below are my recommendations for self-education in Technical Analysis. One thing that all of the recommended books have in common is that the authors are all weary of the financial media, and express their weariness in a sarcastic and humorous manner. There are more that a few good laughs in each of these books as the authors put down the main stream “experts”. While not perfect, charts don’t lie. I can’t say the same for the experts.
Technical Analysis of Stock Trends Edwards and Magee. I would consider this the ultimate text on technical analysis. If you can read and understand this book, you will have the tools necessary to be a successful trader. I recommend that you take this book out of the library before investing the $60 plus for a new copy. The 8th edition deals with the charts of the late ‘90s bubble in a very entertaining way. I would recommend this over, Technical Analysis of the Financial Markets: A Comprehensive Guide to Trading Methods and Applications, by Murphy, which is regarded by others as the “ultimate text”.
Trader Vic, Methods of a Wall Street Master by Victor Sparendeo. There are some good practical applications to technical analysis in this book. There are also several chapters on economics, which describe some important fundamental basics in a compelling way. I would recommend that if you were a casual investor, looking to educate yourself in the basics of economics and also technical analysis, this book would be a good start. Mr. Sparendeo stresses the need for fundamental tools as well as technical tools. While I agree, I must note that in today’s market, knowledge of fundamentals has been a hindrance. (Note: most biotechnology companies.)
Trader Vic, II - Principles of Professional Speculation also by Victor Sparendeo. More practical application of technical analysis applied to stock trading. Sparendeo includes more on economics for the non-economics major. If you liked Trader Vic, you will also like Trader Vic. II.
Stan Weinstein’s Secrets for Profiting in Bull and Bear Markets Mr. Weinstein provides an easy to read narrative on reading stock charts concentrating on the intermediate (weeks to months) term. His methods consist of establishing trends and trading with them. I would recommend this book for the casual investor who is put off by the length and technical detail of Edwards and Magee. It concentrates entirely on technical analysis and does not include fundamental or economic analysis.
Trading for a Living by Dr. Alexander Elder – Dr. Elder’s book deals with trading tactics. It’s a great book for the hard-core trader. It contains very understandable and practical explanations of oscillators and the parameters that you typically see below the price and volume on technical stock charts. There are excellent explanations of the psychological aspects of trading.
How To Make Money In Stocks, William J. O’Neill (Founder of Investors Business Daily). While I question if his methods will work all the time, I have to admit that this is an O’Neil market. He is the hot guru, and there is many a follower of his (including those shown on IBD commercials) practically swearing that his CANSLIM method is a relatively easy sure-fire way to get rich in the stock market. You can’t deny that the technical aspects of his CANSLIM methods are sound (most are in Weinstein’s book, above), and that up until now his methods would have successfully got you into the market to participate in the rally that began in October of 2002. His methods would have also got you out of the bear market while missing most of the damage. The book is a good and worthwhile read. I would caution that as Mr. Elder says in Trading for a living, that the hot guru’s tenure is always finite in its duration. The forget valuation; pile out when the market tells you to method can have some serious impact for the overall market. If this is an O’Neil market, then the first sign of danger will see a large pool of hot money piling out in a manner consistent with CANSLIM. Can the market hit an “air pocket” and fall so fast that there is no opportunity for the internet-trading public to get out safely? The answer would be “no” only if human nature has changed. I question if today’s CANSLIM will become tomorrow’s “Foolish 4”. (The Foolish 4 was a “sure fire” method of beating the average returns of the Dow Jones Industrial Average, established in the ‘90s and recently abandoned by the Motley Fools.)
Come Into My Trading Room by Alexander Elder – More wisdom from Dr. Elder. I preferred Trading for a Living. Trading Room is the more recent.
Reminiscences of a Stock Operator, by Edwin Lefevre – Fictionalized biography of one of the greatest speculators in the early part of the century, Jessie Livermore. This may be the first book you should read if you are considering becoming a hard-core trader. If you enjoy the drama of the stock market, you will complete this book in a couple of sittings. Lefevre describes the trader’s mentality in a compelling way.
Some Short Notes:
1. The Consumer Continues to Do His “Job”
I’ve been hearing rhetoric on business radio and cable that says, “The American consumer is doing his job for the economy by spending”. It begs the question, as a consumer, what exactly is my “job”? From what I’m seeing, my job is to go deep into home equity and credit card debt in order to buy all sorts of gas guzzling trucks, SUV’s, or cars and unnecessary retail stuff made overseas. This should boost profits of the makers, and sellers of the vehicles, parts, and gadgets. In turn, the stock market should continue to kite, at least in the short run. This will boost profits of banks, brokerages and other financials involved with stock market share turnover, consumer credit, and home equity credit. The rising stock market will make me feel wealthy (especially from my 401– K plan wealth), so that I will go out and buy even more unnecessary stuff. (Alternatively, I may consider going on margin in my E-Trade stock account.) Since I will be deeply in debt, I will be totally beholding to my present job, and have to work like a dog to stay financially afloat, while I wait to eventually tap into my kited 401-K Plan. If, as is the trend, my job is transferred overseas, I will be willing to take any available job, which allows me to make my minimum credit card payments. This won’t be so bad, since my 401-K and home equity will still be rising. Working like a desperate dog should boost the government’s economic productivity numbers and further kite the stock market. (Some plan! This works in the short run as it is working now, but is completely unsustainable in the long run.)
As a citizen who is also a consumer, your “job” is to take care of the financial security of your family and yourself by understanding the risks inherent in our current stock and real estate markets. Temper you’re spending habits by understanding what your assets are worth, not what they are selling for in today’s bubble-mania market. This is not time to be a “good American consumer”. It will gain you a complement on cable for continuing to do your “job”, but could be very risky to your family’s financial security.
2. Amazon’s “Imbalance Sheet”
You can’t fake a balance sheet. Here is a graph of Amazon.com’s shareholder’s (non) equity from March of 2000 to June of 2003:
Looks like a healthy company to me!
3. Economic Recovery?
Three weeks ago, I asked readers to e-mail me with their anecdotes of their first hand experiences of an economic recovery or precursors to an economic recovery. I want to thank the readers who took the time to respond. The results are posted (link) for your information (names have been deleted, along with other non-pertinent comments). I think that these comments reflect that the recovery can be found only in the booming real estate bubble and government statistics. Of course, the posted responses were from three weeks ago. Every Thursday, the media waits with baited breath for the government’s weekly jobs number, as if the recovery will appear in the same way that a New York subway arrives at the Wall Street station. So if we assume that things can change so quickly, please keep your observations coming in. Tell me your experiences with the economic recovery.
Today’s Market
After IBM failed to “beat-by-a-penny,” and had sales that slightly missed so-called “analyst expectations” it sold off at the open. But today’s market was saved by a wealth of economic data from the government. The initial jobless claims numbers showed the number of new benefit claimants fell by 4,000 to 384,000. This was advertised in Financial Times online to be the lowest number in eight months. You may have remembered that last week’s number of 382,000 as being lower than the 384,000 reported this week. Last week’s number was adjusted upward to 388,000. The media seems to have spun the 400,000 number successfully in the weekly jobless claims shell game. The public now takes 400,000 as a “good” number, and reason for celebration. Rosy Philly factory data and industrial production data also held up the market. All of the economic data was spun in a positive fashion.
After a few hours the IBM news was all but forgotten. Traders bid the NASDAQ up by another 11 points on low volume. The S&P was up an insignificant 3 points. The Gold and Silver Index (^XAU) was up over 2%, the 10-year bond was down, and the dollar was down. In summary, all of the current trends held true in today’s market action. It will be interesting to see how Ebay’s return to reality from fantasyland affects tomorrow’s NASDAQ market action.
Finally, this from Business Week Online:
“Everybody knows Europe’s sluggish economy is recovering from three years of recession and stagnation far more slowly than America’s. So why is the euro climbing against the dollar and threatening to douse the faint spark of recovery?”
Be wary of “what everybody knows”.
Have a great evening!
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Copyright © 2003 All rights reserved. Martin F. Goldberg, MS, P.E. |
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