Most blog authors on StockCharts.com are writing about the current markets and do an exceptional job. I do not write about the current markets as I wanted to share my experiences after 40+ years as a technical analyst. Not only experiences with trading and investing, but model building and money management. I also share the details of all the Master’s degrees I have – those expensive learning experiences that hopefully I learned something from. Since I rarely go back into the archives of other’s blogs that I read, I wondered if that is common or not. Hence, after talking with Chip, a summary of my past articles might encourage new readers to take a look as most of the material is timeless. That’s timeless, not worthless! This is the second of the summary series and starts in March, 2015 and ends in May, 2015. I’ll try to do the remaining summaries before year end and then do them whenever I have a dozen or so articles to include. You can click on the article name for a link directly to the article.
Chapter 4 in my upcoming second edition to The Complete Guide to Market Breadth Indicators is quite large, so I decided to break it into two articles, this being the first. Chapter 4 deals with breadth indicators that use the difference between advances and declines ( A – D ). As in all the articles that cover chapters in the upcoming book, I just pick out a handful of good indicators to include in the article.
Statistics, and especially the understanding of what they can do is very important in finance and investing. More than that, understanding what they cannot do is critical to the successful use of them. In this article I cover how often technical analysts will use statistics for a trading model. The example is the “Sell in May and Go Away.” I point out all the issues with this and how if it is good 75%, you must remember that some years will contribute to the 25% of the time when it doesn’t work. It is used to create trading activity and sell books more than having any value in trading with real money.
This is kind of a nerdy article but is necessary because of the amazing number of folks who do not understand alpha and beta, yet drop those terms frequently. I give examples of how it is calculated and graphed, along with all the boring details. I then explain that with linear analysis, for alpha and beta to be of any value the data must be correlated. If it isn’t the alpha and beta are meaningless. Sadly, most websites show alpha and beta without any reference to correlation.
I introduce rolling return charts showing market performance on a rolling basis. This is a great way to see performance and how it changes over time. For example, if you are looking at the 20-year rolling performance of the Dow Industrials since 1900, the chart’s first data point would be in 1919. The second data point would be from 1901 to 1920, the third from 1902 to 1920, and so on. You will clearly see that there are periods when buy and hold just does not work well. I next show the distribution of returns based upon percentages such as <4%, 4%-8%, 8%-12% and >12%. You will see that based upon 20 year returns over 43% of the returns are in the <4% area. These are great ways to understand how markets have behaved. Other distributions are based up deciles and standard deviation.
I have stated often that Drawdown is what risk is, not the foolishness of using standard deviation. This article delves into how I calculate drawdown and shows charts of it for the Dow Industrials back to 1885. Most people think the market is making new all-time highs much percentage-wise than it actually is. The chart shows that it ranged from 1.5% up to almost 4% in recent times. That’s right, the Dow Industrials on a daily basis only made new all-time highs less than 4% of the time. I also show a table of drawdown data for various percentages over the 120+ years of data. Remember, drawdown is not just magnitude, it is also duration.
If I had to pick on personal trait that I believe is paramount to successful investing, it would be discipline. Exceptional Discipline (the other E.D.) and objectivity will keep you from falling victim to short-term emotion and chasing something new, even though you know your long-term methods are sound. So, why do we believe information that does not hold up under scrutiny? Simply because we are human! If it total foolishness to count on your emotions when the going gets rough. You must have a disciplined process – period.
This was a fun one to write as I talk about some of the things we have accepted as fact for most of our lives, which are simply not true. George Washington cut down a cherry tree, and many more are shown with the hope that I will cover one you believed only to show you it was not true. If I have shown you something you believed that is not true, then how much about investing have you accepted as fact that simple is not so? Here are some of the subtitles in the article: Diversification will protect you, Compounding is the Eighth Wonder of the World, Buy and Hold will keep you from missing the 10 best days of the year, and Economists are good at predicting the market.
We have breaking news! But first we will be right back after this message from our sponsor. That sort of says it all doesn’t it? Isn’t all news breaking? If you watch the financial media long enough, you will realize that they attempt to assign a reason for why the market is doing what it is doing. Yet, it rarely is. Here is a humorous example: On Wall Street today, news of lower interest rates sent the stock market up, but then the expectation that these rates would be inflationary sent the market down, until the realization that lower rates might stimulate the sluggish economy pushed the market up, before it ultimately went down on fears that an overheated economy would lead to once again an imposition of higher rates. Turn off the noise!
I cannot count the times I have seen a technical analyst totally misuse a classical chart pattern like the head and shoulders pattern. I review the details from Edwards and Magee on the definition. First of all, it is very rare to see a head and shoulders pattern that fully meets all of the requirements. It seems that some think they are making points with their peers if they are the first to call it out. I suspect there is never any real money involved in these situations. I also offer a way to improve the results of the head and shoulders pattern. Remember, it is a reversal pattern so it has to reverse something. What is that? It is the preceding trend. Don’t forget that.
In my Investing with the Trend book, I have a number of pages devoted to Secular markets. I see the term secular bandied about, but Ed Easterling has defined it for the stock market in a way that makes sense (cents). The driver of these secular cycles is the inflation rate as it moves toward and away from price stability. Trends of rising inflation and deflation drive the market valuation lower and results in low returns. As prices stabilize from either deflation or high inflation, valuations are driven upward and result in high returns. Moves toward price stability simultaneously cause PE to rise and result in high returns.
I sometimes wonder if young technical analysts read books like us old guys did. When I started there was no internet, only books and newspapers. Barron’s was a source I used for decades. A short story about my introduction to a Marine drill instructor begins this article. I offer my short list of recommended reading and then follow up with a much longer list. You will learn more from good technical analysis books than from listening to the experts on television.
How many times have you bought something spontaneously, then after you got home regretted the decision? Investors seem to forget history when making investment decisions. The amount of time since the last bear market is well over 6 years and many, if not most, have forgotten that bears will rise when most are unprepared. I discuss creating a simple process for investing that leaves out the emotions, the spontaneous decisions, and provides rules to keep you in your process.
Just below in the section about me you can click on my name and see a number of interviews I have done lately. If they all start to sound alike, then just wait until you are older. Thanks.