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Classrooms Home Street Smart Report Home Seminar #1. THE FOCUS OF TECHNICAL ANALYSIS.Technical analysis ignores the economic, political, and fundamental conditions that surround the market, as well as bullish or bearish prognostications from Wall Street. It concentrates on what the market is actually doing, rather than what the pundits say it should do. Until the middle part of the century, technical analysis was practiced by few, and was looked on as some kind of worthless hocus-pocus by those who had yet to look into it with any seriousness. Since the 1950's however, as it increasingly proved its value, particularly after the introduction of computers allowed the accumulation and analysis of much more data, technical analysis has become an important part of most professional and serious investors' arsenal of tools. Virtually all Wall Street institutions utilize technical analysis to the same degree they utilize fundamental analysis. But one would never know that from the presentations of mutual fund and brokerage firm spokesmen on financial shows and in the published media. There one hears projections for the future performance of a stock, or the overall market, based solely on fundamentals of sales and earnings trends or what have you, and guesses as to what kind of price/earnings ratios investors should be willing to apply to those fundamentals. There's a reason for that. If they got on TV and talked about how the charts of a stock are showing a pick-up in big block accumulation on pull-backs to support at a rising 20 week moving average, a pattern of higher highs on each rally off the support, higher volume on the rallies and lower volume on the pull-backs, few viewers would understand what they were talking about, or see that as signs of a potential rally coming in the stock. However, their talk of exciting products, or good management, or rising sales or earnings, is easily understood, makes for a more exciting segment of the show, and above all is an easier sell, which is after all the purpose of the appearance. It's not a new situation. A prominent brokerage firm partner in the 1920's recounted in his memoirs how he chose stocks for his clients primarily using technical analysis. But when his technical analysis turned up a stock he wanted to recommend, he then had to uncover some fundamental conditions that sounded good, so he could convert his technical analysis for being bullish on the stock into the kind of talk about the company's products or sales that the clients were used to, and could accept. While we're in the old days, the story of one of the first investors to trade on technical analysis and charting alone, without any regard at all for a company's fundamentals (not recommended), is very interesting. Jesse Livermore was a young teenager who started working at a brokerage firm as a "board boy". This was before the introduction of ticker tape machines. It was his job to write the price and number of shares of each trade as they were reported, on a large blackboard where everyone could see it. He knew nothing about the market, even less about the business of the companies whose stock trades he was recording. They were just numbers to him. But, out of boredom he started paying attention to the pattern and flow of the numbers, and trying to guess whether the next trade would be higher or lower. He had noticed some stocks would rise for only so many trades, or so many days, and then the trades would take on a different pattern, and within days the prices would begin to fall. Other patterns seemed to take place just before stocks began substantial rallies. He began to record what he was seeing in a notebook. Satisfied that he wasn't hallucinating, a couple of months later he convinced one of the brokers to let him make a trade with all the money he had in the world, $5. To make a long story short, he quickly turned that $5 into several thousand, quit his job, and became a full time stock trader. Before long he had a staff of "technical analysts" watching the tape for the patterns he had seen. Livermore had a colorful career, making, then spending and losing multi-million dollar fortunes several times. The tools of Technical Analysis. Chart Analysis. Charts provide a broad array of information about a stock or a market in a very efficient manner, including but not limited to, its historical performance, its current trend, its historical volatility, its past patterns at tops and bottoms, whether it is approaching areas that have proven to be overhead resistance in rallies in the past or that have provided underlying support in previous corrections. Various types of technical indicators applied to the charts, either as overlays, or in separate 'windows' of the chart, can provide a broad array of information including whether the stock or market is "overbought" or "oversold"; whether its undergoing accumulation or distribution; whether its short or intermediate term momentum has "run out of steam" or even reversed to the other direction, etc. Sentiment Indicators. Sentiment indicators measure the market psychology (degree of bullishness or bearishness) being evidenced at any given time by specific groups of market participants. Many years of observation have shown certain groups tend to be wrong at market turning points. They are therefore referred to as contrary indicators. Other groups tend to be consistently right at market turning points. Those who, as a group, tend to be wrong at market turning points include
As a group, they tend to be fully invested and enthusiastically expecting still higher prices at market tops, and to belatedly sell near the lows and be under-invested and expecting still lower prices at important market lows. Those who, as a group, tend to be right at market turning points include
As a group, they tend to sell into the strength as a stock, or the market, nears a top, and thus hold higher than normal levels of cash at the top, and to begin buying as the next important low approaches, so tend to be fully invested at the low. While both groups are usually right when the market is in a trend one way or the other, technical analysis watches for their bullishness or bearishness to reach extreme readings which in the past have signaled the market is approaching an intermediate term top, or correction bottom. Market Internals Market internals is the phrase used to describe a variety of situations that are going on beneath the surface of the market, the surface being the readily observed Dow, S&P 500, and NASDAQ Composite. The health of market internals usually reveals truths about the market that the health of the indexes may be masking. Market internals include market 'breadth' (a comparison of the number of stocks in the broad market that are rising to those that are declining), the number of stocks making new 52 week lows compared to the number making new highs, etc. Technical analysis looks for signs of latent strength and weakness in market internals, for early alerts to corrections bottoming, or rallies topping out. Seasonality Seasonality is a most important feature of the market. Very strong seasonal factors exist in both short and long-term patterns. The seasonal patterns are due to money flow patterns which for instance, tend to be strong near the end of each month and each quarter, and on a longer term basis, between November and May. In upcoming seminars we will get into the details. Stay tuned! |
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