Technical analysis offers an unbiased truth about the markets. I am writing this article because I have a large number of new readers. I addressed this subject a few years ago.
If one is going to follow and utilize a particular discipline, hopefully they have done a thorough investigation as to the benefits and pitfalls of that discipline. I’ll share a short story from the mid-1970s, a period of my life when I was a Navy fighter pilot, and of course, knew everything and was immortal. I had a few thousand dollars that I wanted to invest. I honestly can’t recall my source for research, but I’m almost positive I didn’t pay for any of it; probably a trip to the Dallas Public Library and probably the Value Line Investment Survey. This is a giant black ring binder with a single page dedicated to a single stock in the Value Line universe of about 1700 issues. I know the research was quite thorough and it probably took me a few months to even work up the nerve to actually speculate (I called it invest back then) in the market. I don’t even recall the small brokerage firm I used; but do remember that discount firms were being talked about, but none were in existence then (I think). There was no FNN (Financial News Network), CNBC, Fox Business, or Bloomberg television in those days.
My research efforts involved the typical fundamental review looking for stocks that met a host of different criteria using ratios such as Price to Earnings, Price to Dividend, Price to Book, etc. I do know that the Price to Sales ratio had not been created yet. I think it was developed by Ken Fisher in the 1970s and become widely used in the 1980s. So, I buy two stocks in late 1972; I remember that one of them was UAL (united airlines). Clearly my bias for aviation was part of the decision. A bias that this book is trying to teach is totally wrong. For two months they went straight up. I have to be honest; I thought I was truly brilliant. I was euphoric. Then in early 1973, my brilliance turned to anxiety when the prices of both stocks started to decline. Fear of losing money was now dominating my thought process. Strangely, nothing entered my mind in regard to selling those stocks or putting a stop loss order in (doubt I even knew what that was then), I just knew I was right and was going to prove it. Well, as I recall I held those two stocks until sometime in 1975. They had declined with the market and by the end of 1974 were down 75% from where I bought them. I had no stops, I had no plan, I had no money management, I had nothing but an ego that kept me totally wrong for two years. The market started up in early 1975 and I was so happy to unload them for a few percentage points above their bottom, I swore I’d never gamble in the market again. However, I remember that it sure made me feel good to buy a stock because the financial ratios were good. Fortunately, I quickly learned that feeling good has very little to do with making money in the markets.
It was then that I read a book, suggest by a good friend, called, “The Art of Low Risk Investing,” by Michael Zahorchak. I had previously read a few other books on technical analysis but none of them involved a process, they usually dealt with chart patterns, etc. Zahorchak offered a complete and rational technical process to investing. The book has long been out of print, but I’m sure you can find it on eBay or somewhere. If you are having doubts about technical analysis, this book will correct that. I have never deviated from technical analysis since that experience in the mid-1970s; I believe it is the best way in which to help an investor control their emotions during the investment process.
Previously I wrote some articles about the Zahorchak Method and it is also in StockCharts.com’ Symbol Catalog. Here are links to those articles:
Now, within technical analysis there are many varied approaches. Many of which I have tried but was not successful. I like to say that I have a master’s degree in what not to do as those lessons came at a significant cost. As I have aged, I have slowly learned not to speak in absolutes about the market, as any approach that one can use to be successful is the right approach for that person. Just because I don’t care for some approach does not mean that someone else cannot use it successfully.
There are different types of market analysis. The most widely used is Fundamental Analysis, which focuses is on multiples or fundamental ratios. Almost 90% of these ratios use Price, usually in the numerator or sometimes in the denominator. Price Earnings Ratio, Price to Sales, Price to Dividends, Price to Book Ratio, etc. are just a few of them.
Technical Analysis, however, is the analysis of Price. Price is what we buy. When you buy a stock, you are not buying the earnings, the products, the management, dividends; you are buying the stock at a market generated price. Those other things might be why you buy it, but they are not what you are buying, you are buying the stock.
Trend determination is the trend of the price that we are analyzing. Trend analysis is a significant part of what this book is all about. See later chapters. Breadth analysis is a derivative of price movement. Breadth analysis is dealt with extensively in the Appendix. It is a critical contribution to technical analysis. Relative Strength analysis is the analysis of one group relative to another. An example of relative strength is the relationship between small capitalization stocks and large capitalization stocks. However, most importantly, technical analysis bridges the gap between doing the analysis and taking action – it is just the next step.
Dance with the Trend,