When your analysis indicates a major bear move in your target stock, you hesitate because you think that there is only room for a small move downward, since the cur- rent price is almost equal to the book value. Your conclusion is that it cannot move below book value. My reply: “When pork bellies fly!” A famous trader and trading system developer named D. W. Gann once said, “Gentleman, it can always go to zero.” A lot of stocks trade below book value or some other value that is supposed to be etched in stone. If your analysis says it is going lower, believe your analysis. Of course, you might want to trade lightly, use a tight stop, or enter a position gradually.
Always err on the side of caution, especially in the beginning, when you are at- tempting to understand and interpret the data accurately. Often the nuances of the data for certain industries are not well understood by the universe of traders. What may sound good at first may not be good in actuality. If your analysis depends on a weak jobs number and the month’s report is flat compared to last month, the ac- tual situation may be worse than it looks at first because of the number of people who dropped off because they quit looking for jobs. My point is that you need to understand the data completely and all the possible interpretations before reaching conclusions.
Always take seasonality into consideration. A key statistic may be lower or higher than you expected. But before you bet the farm, check out comparable fig- ures for the same period in previous years. Some retailers, for example, make over 70 percent of their profit during the Christmas season. Also, if you are missing a key piece of information, do not jump the gun. Wait until you have all the facts.
Remember, a bus leaves this corner every 15 minutes—good trades are always coming down the pike, and the patient trader wins.
generally the same technical tools no matter what entity is under analysis, includ- ing options. The skills and systems that you learn apply universally. The scope of TA is so large that there is no way I can provide anything more than an overview.
The purpose is to introduce you to TA and give you a rudimentary understanding of the subject.
To anyone new to financial analysis, it is somewhat easy to understand why fun- damental analysis works. If a company is making money, it is worth more. Higher earnings equals a higher stock price. It is also simple to understand the other fun- damental factors contributing to higher earnings. The better product captures more market share. The better management team makes better decisions—and so on ad infinitum. The changes in causes and events are transparent. FA appears to be com- mon sense to the skilled and the unskilled analyst.
When it comes to technical analysis, newbies often balk when they see an an- alyst look at a price chart and say with absolute confidence that the bull move- ment currently in progress will halt at a certain price. Or they see an analyst draw a few lines or make a few marks on the chart and say, “Looks like it’s time to short.”
Another thing that always blows new traders’ minds is the incredible variety of different approaches (see Figure 8-1). As an illustration, I often show stu- dents James E. Schldgen’s book, Analytical Methods for Successful Speculation.
This 275-page paperback is a study of gold from 1975 to 1985 using fundamen- tal and technical analysis. The pertinent part for those who are new to trading is all the different technical approaches illustrated. First Schldgen looks at correla- tion analysis. If oil or the dollar goes up, how does gold respond? Besides these two, Mr. Schidgen correlates gold with banking reserves, budget deficit, the Commodity Price Index, the Consumer/Producer Price Indexes, corporate prof- its, gold stocks, industrial production, world money inflation, the trade deficit, and a few more. He then analyzes gold using 36 separate TA tools. Here is a partial list:
• Accumulation/distribution price analysis
• Bar chart analysis
• Commodity Channel Index analysis
• Contrary opinion analysis
• Elliot Wave analysis
• Fan line analysis
• Fibonacci progression analysis
• Fifty percent retracement
• Gann, W. D., analysis
• Harahus pentagon analysis
• Moving-average analysis
CHAPTER 8 Fortune Telling 101 121
Figure 8-1.
• Oscillator analysis
• Parabolic analysis
• Point-and-figure analysis
• Psychological crowd profile analysis
• Speed resistance line analysis
• Stochastic analysis
• Three- and four-dimensional chart analysis
• Volume and open interest analysis
If this isn’t enough, there are dozens and dozens more—check out www.techni- calanalysis.com for fun. The number and complexity of the TA studies and sys- tems is simply mind-boggling. When you start out, you must do it in a controlled manner or you will become overwhelmed. Guard against jumping from one ap- proach to another haphazardly.
I want to discuss a few of the most widely used forms of technical analysis to give you a feel for how and why they work. One of the most important issues is, why are there so many TA approaches? How does one select the one that is best suited for him or her? Which one or ones work? You must also keep in mind that there are individual studies that tell the technician a specific piece of information, such as that the price of a stock just dropped below an uptrend line. In addition, there are complete trading systems, often composed of several individual studies working in concert, that alert traders to opportunities and specify the prices at which to open a position, take profits, or cut losses. At times, it can be confusing which is which.
Technical analysis is so widely used that it often becomes a self-fulfilling prophecy. For example, up and down trendlines and moving averages are widely followed. An uptrend is a series of higher highs and higher lows in the price of a stock, option, or future. A downtrend is the opposite—a series of lower highs and lower low prices. When a trendline is broken by price movement, it is a sell signal if an uptrend is breached and a buy if a down trendline is broken. In other words, the trend has reversed.
A moving average is simply an average of a series of prices (5-day, 30-day, 100-day, 200-day) that is plotted on a graph. After each period (minute, hour, day, week, month, or some other period), the last number is dropped and the new one added, and the total is averaged. If a moving average that is trending up and is plot- ted on a price chart on which an uptrend line is drawn begins to fall, it eventually penetrates the uptrend line, signaling a sell or a shorting opportunity. The opposite is true—a down-trending moving average reversing and piercing a down trendline alerts traders to a buying opportunity. The 200-day moving average is particularly important for stock traders because it represents approximately a year of trading.
You will even hear it mentioned on public forums, like CNBC. As a general rule of
CHAPTER 8 Fortune Telling 101 123
thumb, the longer a trend, the more reliable it is. So many traders follow the key TA signals that when they see one, they all act in concert, fulfilling its prophecy.
TA assumes that everything you need to know about a stock, option, or futures contract resides within its price history. By studying that history and converting it into various forms, the technician makes predictions as to what future prices or trends are going to be. To be able to accomplish this, there must be some repeti- tious patterns that can be discovered, as discussed at the opening of this chapter.