Technical Investment Analysis:
Rather than try to cover the background material myself, I will point you to various sources of info that I find useful.
Books and Seminars
Any books or seminars by John Murphy or Martin Pring, a fellow I used to know, are highly recommended. They cover the full spectrum of the technical analysis field and do a solid job.
Pring's DVD is recommended as is his blockbuster book, Technical Analysis Explained.
Also, any educational material offered by the Market Technician's Association is professionally done. A MTA DVD by Ian Notley, my mentor, is also recommended.
Free Websites
For free online charts, I like three Internet services:
(i) www.StockCharts.com
(ii) www.BigCharts.com
(iii) www.BillCara2.com
Equis, the company that sells the MetaStock technical analysis software package, has done an admirable job of educating the public about most of this subject. I used to spend quite a few hours on their web site, but they removed it from public view.
Another website that I've often used is from Equity Analytics, Ltd.
I am not prepared to recommend any single free reference source material as being the best, but if I did, it could possibly be StockCharts.com.
Application Software
All technical analysis requires an understanding of time series data.
There is a lot of technical analysis software in the marketplace but most of it is a complete waste of time and money. Some of it is free.
MetaStock from Equis International represents itself as the world leader.
As for commercial technical analysis software, there are many good ones. But recently I have observed a number of stock trading software-based get-rich-quick schemes selling their wares via slick television infomercials and full-page newspaper ads that sell "free" seminars and workshops.
I researched a couple of these and couldn't find any credibility whatsoever. Most are charlatans. You'd waste your time and money in getting involved.
One of these vendors charges between $3,000 and $4,000 to offer what apparently is little more than a simple moving average analysis program. But, the infomercials sell this program as the public's answer to beating professional traders in the equity and forex markets. It's not.
There is no magic to securities trading, and certainly no rocket science to technical analysis and algorithmic trading. The technical aspect must be supplemented with a comprehension of the fundamental, quantitative, and economic aspects plus working knowledge of short selling, options and futures, and so forth.
As a student of the market, you ought to try to learn as much about technical indicators as possible, but stick with the basic concepts. When you start to smell the rocket fuel, it's time to back off.
The Time Factor
Rather than get deep into the wide-ranging tools of technical analysis, I am going to focus on the aspect of it that most appeals to me, which is time series analysis.
Technical analysis is based largely on a single factor: market prices. As prices change literally by the second, for various reasons, you must have an understanding of the time factor before you will become a successful trader.
Time Series Analysis
Market prices are either rising or falling; the trend outlook is either good or it is bad. As a trader of securities, there is always a time when you have to make a decision and that should be the time when a price series reverses trend. Then there is a time when you ought to just let things ride.
The longer you study and participate in capital markets, the more you will be conscious of its rhythms. The more you will see clearly that the capital market is a natural phenomenon.
The Book of Ecclesiastes, Chapter 3, pretty much says it all to me: "There is a time;"
1 To every thing there is a season, and a time to every purpose under the heaven:
2 A time to be born, and a time to die; a time to plant, and a time to pluck up that which is planted;
3 A time to kill, and a time to heal; a time to break down, and a time to build up;
4 A time to weep, and a time to laugh; a time to mourn, and a time to dance;
5 A time to cast away stones, and a time to gather stones together; a time to embrace, and a time to refrain from embracing;
6 A time to get, and a time to lose; a time to keep, and a time to cast away;
7 A time to rend, and a time to sew; a time to keep silence, and a time to speak;
8 A time to love, and a time to hate; a time of war, and a time of peace; ;;.
There is always a time when things are low and a time when they are high. Ecclesiastes acknowledges this.
I now face this time dilemma in my personal life (1Q05). With the greatest sorrow, it is the time that both my parents are likely to die. Then, too, I have a brother whose offspring have brought four babies to life in the past two years. So, there is a time to be born, and a time to die;
From birth to death, from sowing seeds to harvesting the crop, we all have a cycle. So does the market.
We do not have to get into a discussion of sun-spots, lunar phases, menstrual cycles, the four seasons, and the like, to know that there is a rhythm to our lives.
If there weren't any discipline, we'd all be in the nut-house.
It's even people like you and me who program the computers that execute automated rules-based buy and sell programs in the market. That means that the so-called "artificial intelligence" of computers is human intelligence, operating by natural laws. No magic involved there either.
I accepted, as fact, the notion that the market does have cycles once I came to an understanding that the market is just "people acting like people". Ian Notley taught me that, for which I will be eternally grateful.
The Market is About Life
Thirty years ago, an academian by the name of Burton Malkiel wrote a popular book called "Random Walk Down Wall Street". In it, he states his belief that stock prices are completely random, that you never know from minute to minute, day to day, what's going to happen in the market.
Subsequently, serious investment disciplines developed from this theory.
All I can say is that the man never traded stocks, bonds or commodities. I wonder if he ever understood the market as a natural phenomena, which, like life, has a rhythm.
The market doesn't represent chaos or randomness any more than your life or mine. Great writers like William Shakespeare or Victor Hugo would have understood that both are, in fact, a dance.
Malkiel's book, while popular in academia, is one that real-world people ought to avoid. There isn't a single person who trades financial instruments for a living who believes that prices are random.
Life might be fast and seemingly chaotic at times but mostly its just natural, with a lot of routine, based on the same fundamental needs shared by all human beings, filled with the basic emotions of fear and greed, happiness and unhappiness, and so forth.
Like me, you have your good days and your bad days, your good moods and your bad ones. You do some things right and some things wrong.
The capital market is the same.
Rather than give Makiel's patently nonsensical Random Walk another thought, I strongly recommend you focus on the highly practical Dow Theory, of which three theorems stand out:
(1) Price movements are not totally random; there is a "Why" to all price movement
(2) "Why" is important, but "What" is more important than "Why"
(3) Price discounts everything (although it does so inefficiently)
Mastering the Basics of Technical Analysis
Technical buy and sell signals using Time Series Analysis of market data is an application of mathematics but it is not science.
Technical signals " in every case -- are called indicators for a good reason " they are not precise. All of them work some of the time; none of them work all of the time.
Having said that, I do rely on them as much as fundamentals like discounted cash flows, price-earnings ratios and earnings growth rates.
Students, keep in mind that technical analysis is just one of three approaches to making investment decisions (technical, fundamental and quantitative) and all have a place in your school bag.
I'd truly like to cop out from getting into this subject in detail because it would be a little like trying to teach golf or tennis over the Internet. It's something you just have to experience for yourself. But, here goes.
The part of technical analysis that I think is most important is the subject of time, that is, Time Series Analysis.
Probably no other free service on the Internet gives a better education of technical analysis and Time Series Analysis than StockCharts.com. StockCharts.com will give you the start you need.
I strongly recommend that all students of the market read and master the principles that StockCharts.com offers in Part 1 and Part 2.
When you get the hang of it, you can move on to looking at special situations that professional and semi-professional chartists make available free on their web site.
Something that may be apparent; it's hard to have a discussion about technical analysis, time series analysis or market timing, without encountering much prejudice and discussion about the randomness of market prices, or the need for bottom-up fundamental analysis, or so on.
All I can say is that you have to learn it all or else you will never become self-dependent in your investment decision-making.
I defy anybody who truly believes that market prices are random to use their dartboard in competing in real dollar trades against an expert's use of technical indicators.
The fact is that there are trends and there are cycles to capital market prices, which are caused by the natural actions and reactions of people like you and me who make investment decisions.
There are probably 100 different technical indicators explained thoroughly on various internet sites. The technical analysis service at BillCara2.com uses 12, with variations, to derive 20 different signal generators. The system runs these 20 indicator programs against many thousands of stocks to determine average signal performance against a buy-and-hold yardstick. It calculates the "strong" results against the buy-and-hold yardstick. By the word "strong", they mean alpha, which is the measure of value-add performance.
A user of this particular service can change the conditions of the signal generators, and even delete some of the indicators, to see how their particular style of technical investing would size up against the buy-and-hold scenario.
Invariably, the technical trading system wins.
There is no reason it shouldn't. People don't change much from generation to generation. Regardless of all the education, the added knowledge and experience and so forth, people still act basically on fear and greed. That won't change so these programs will continue to work.
At the top of cycles, when trends are reversing and heading down, these technical programs are not distracted by the sales drivel spewing forth from Wall Street. Instead, objective mathematical formulae are being applied to actual trading data (not stories, or earnings estimates, and so forth) and the results show that buy-and-hold investors are trading at their peril.
Trading in and out of the market over days, weeks, and months (depending on your requirements) is a superior strategy regardless of what Wall Street is telling you.
If you're driving through an intersection on a green light, you expect to get by without incident; but you still keep a lookout for danger and you will take evasive action when necessary.
The same process applies to the market. For reasons of marketing, however, most investors go blindly forward, following Wall Street's lead, regardless of the dangers that routinely appear. They take their eye off the ball, which is the factual market data like prices, actual earnings and so forth, and listen instead to stories, forecasts, viewpoints, and so on. Then they drive right through red lights.
Like defensive driving, time series analysis helps you stay on track.
Technical buy and sell signals have proven to be value-added indicators for good decision making.
BillCara2.com uses 12 technical indicators. In no particular order, they are:
(1) Moving Averages,
(2) Relative Strength Index,
(3) Money Flow Index,
(4) Stochastics Oscillator,
(5) Moving Average Convergence/Divergence,
(6) On Balance Volume,
(7) Commodity Channel Index,
(8) Sibbet Demand Index
(9) Price Rate of Change,
(10) Detrended Price Oscillator,
(11) William's Percent R, and
(12) Bollinger Bands.
In my day to day work, I use about 6 or 7 of these, relying mostly on RSI, Stochastics and MACD, and 2 or 3 others.
To me, far too much is made of the complexities and sophistication of technical analysis.
I feel the use of an indicator is merely a starting point, so I don't want to spend all my time on indicator calculations. Besides, my view of an individual stock is affected by my take on other aspects of the market.
I prefer to see a few of these technical analysis tools applied across a spectrum of the market: the sectors, industry groups, industries and sub-industries. Using the same signal generators, I then want to drill down into the various key market influences such as interest rates, consumer and capital spending and commodity prices.
You see, the market never operates in a vacuum.
As well as using these technical tools, I also apply various fundamental and quantitative tools because I'm not comfortable taking a single-minded approach to decision-making.
At the end of the day, I'm looking to make up my decision on the best data and the best data analysis tools available to me and that definitely includes time series analysis.
The Technical Indicators I Favor
To repeat the most important point, you can get wrapped up in these technical indicators and start to think they represent a scientific approach to investing and trading. But the fact is some of them work some of the time. It's more art, than science.
I use the following technical indicators every day "but in combination with fundamental and quantitative studies plus a healthy dose of intuition and common sense. I never rely on technical studies alone -- and neither should you.
(2) Stochastic oscillator
(3) Moving averages
(4) Moving Average Convergence / Divergence
(5) Trend lines
Technical indicators are marketed as a scientific approach to investing. If that were true, every engineer would be wealthy. Unfortunately there's as much art as science involved -- even in the interpretation of these technical indicators.
Because they use the same time series data and tend to use the same underlying mathematical concepts, the results of these indicators are somewhat biased. Nonetheless, I believe that some technical indicators are valuable tools and I use them daily in concert with fundamental and quantitative indicators.
The fact is you will never be perfect. At the end of the day, if you can be 60% or 70% right in your decisions and keep your average percentage loss below your average percentage gain, you'll become a highly effective and successful securities trader.
It's nice to have big dollar wins but it's more important not to have big dollar losses. A 90% loss in a position requires a gain of 1000% in that holding to recover. Think about that!
If you lose as much as you win, as often and in percentage terms, you soon will not have any assets left. If you don't believe me, start with $100,000; then take a 50 percent loss (leaving $50,000); then earn a 50 percent profit (leaving $75,000); then take a 50 percent loss (leaving $37,500); then earn a 50 percent profit (leaving $56,250); then take a 50 percent loss (leaving $28,125); then earn a 50 percent profit (leaving $42,188); then take a 50 percent loss (leaving $21,094); then earn a 50 percent profit (leaving $31,641); then take a 50 percent loss (leaving $15,820)... you get the point.
So, traders have to be defensive before they go on the offensive.
More than anything, I feel that technical tools can really help you take that necessary defensive posture.
If, in addition, you have the luxury of time, and a lot of patience, you can also use them to become an aggressive investor and your percentage of good decisions will also increase. At least, that's my experience.
Algorithmic Trading
More than 25 years ago I wrote in a magazine article that one day computers would beat the chess grand masters. It was unthinkable at the time, whereas I thought it was inevitable. It was.
Times change in the capital markets too. Today I'd put my money on the black box (i.e., algorithmic trading) being the superior trader in the capital markets. At least 30 percent of hedge fund, pension fund and mutual fund managers agree, because that many were using them by 1Q05.
There have in fact been many software systems developed for the automated buying and selling of securities. Wall Street is full of them. They are referred to in the financial services industry as "black boxes", mostly because nobody knows what's inside " just that it's supposed to work.
This type of sophisticated technology is today flying jumbo jets and guiding bombs, with incredible accuracy. There is no reason to question its applicability to capital markets.
Rather than have any doubts, however, I designed such a system and hired a couple systems developers and programmers to help me build it.
In June 1993, the editor of Canada's Financial Post, a leading newspaper, studied my system for a day and was impressed with the results. For about 850 stocks (all of them where the data was available in the Business Week 1000), using a protocol that switched only from long to short and back for every stock in that group over that time (meaning we were fully invested 100% of the time), back-tested for 4 years, I proved 85+% wins plus average gains that exceeded average losses. The average holding period, by design, was about 1 year.
Excellent results! No, they were better than excellent.
Unfortunately, there were so many automated decision systems in the capital markets then, in fact, that when I tried to sell my system on Wall Street in 1993 (through a well-connected sales professional), I found the task impossible as the marketplace was already flooded by well over 200 such systems.
Due to personal circumstances, mostly because I moved to Bahamas where I ran a different type of trading business, I never continued to build the block box.
Today there must be thousands of rules-based trading systems, although, like my old one, I suspect that many have been put on the shelf. I remain optimistic however. Recently, I began designing a new algorithmic trading system.
With so many portfolio managers using automated decision systems in the capital markets, I'm sure programmed trading is here to stay.
Here is a link to a very well done web site for a system being widely marketed today. I suggest you look at it for reasons that explains a lot about these types of systems:
As at year-end 2004, this particular system claims to have gained 3494 percent from January 10, 2000. That's 35 times your money returned in five years. I wonder if any professional money manager can make the same claim?
Wins / Losses / Win % / Avg Gain / Avg Loss
353 / 252 / 58.35% / 9.83% / -6.59%
I last looked at this advertisement in October 2003. Since then, the numbers have even improved.
At the earlier point, with a win percentage of 58%, by keeping the average gain above the average loss, promoters of this system claimed to have multiplied the starting capital 18 times in less than 4 years. Now, it's 35 times in 5 years.
Do I believe results like these are possible? My answer is a qualified "yes" and here's why.
I do believe that many rules-based systems are effective but, to really work long-term, I also believe you have to make a 100% commitment to the discipline. It also requires having to continuously tweak the software instructions.
Therein lies the key problem; these systems need a single manager to be effective. Too many suffer the '12 PhD's from Stanford' syndrome.
The person who operates a so-called automated decision system must be like a Michael Schumacher driving his Formula One Ferrari. He or she becomes part of a system. To an expert securities trader, these systems are merely tools, not black boxes that will guarantee financial success.
Now what follows is why I don't care to get involved with most of the promoters of black boxes you see on paid-TV infomercials and the like.
They are sold by Multi Level Marketing (MLM) people, most of whom have little understanding of investing/trading. They sell them to people who are seeking wealth the easy way, without trying to understand the basics of investing/trading. That's a formula for disaster.
Here is the MLM promotion for the Financial Picks system, which is the case study vendor that supposedly has returned 35 times your money since January 2000.
Financialpicks.com 2-Tier & 3-Tier Affiliate Program
Financialpicks.com Join our affiliate program - for free - and start generating 20% of every sale made from your referral. And the best part...you keep getting 20% of the membership fees each and every month that person stays a member.Earn 10% from Tier 2 sales and 5% from Tier 3 sales. Join this Top Earning stock market affiliate program Click Here Now!.
If, for market novices, any system is capable of producing results like this one claims (3494% in 5 years) and must still be sold by MLM, then I believe it is probably not worthy of your time or money to get involved or even to look into.
For evidence, I point you to the track record of the best-managed and best informed and technology equipped mutual funds on Wall Street, 80% of which cannot even keep up to the major market indexes, in performance terms.
That is not to say FinancialPicks.com is not a superior product. I just don't have the time or inclination to get to the facts.
I'm just too busy being a student of the market, and writing this website/blog material.
Posted by Bill Cara at February 4, 2005 10:11 AM
