STOCK MARKET: TECHNICAL ANALYSIS

TECHNICAL ANALYSIS
Which mistake taught you the most?
It was trying to make more of technical analysis than it is. The biggest mistake people make is to overburden themselves with indicators. The simpler you keep it, the better it is. In my early days, I was trying to do too many things with the subject, but we didn’t have that many indicators anyway. Now, with the advent of the computer, they’re back-testing everything and trying to reinvent the wheel, and I don’t think you have to do all that. Keep it simple. I interviewed Richard Russell, who is the living guru of Charles Dow, and I asked him what advice he’d offer the younger generation of technicians. He said, “Always follow the major trend.” If you understand the major trend in the market, then everything will fall into place. I agree with that.

Describe your style of technical analysis.
I’ve been in the business for almost forty years. I think the biggest thing I bring to the table—and that’s probably what distinguishes my style—is history. I was a history major in college, and I love it. A few reports that I have been successful in writing basically reconstructed historic events; I then applied the historic events to the current market. It worked. That’s what technical analysis is; it’s history.

In what kind of market conditions do you make the most mistakes?
In a trending market, I believe, things are easier. In a nontrending market, which is by definition much more volatile, the odds of making mistakes increase. For example, moving averages are very helpful in trending markets. They keep you in a direct path. However, don’t ever use moving averages in trendless markets, or at least be very careful when using them there, because you’ll get whipsawed. But once you identify a nontrending market, there are certain things you do and certain things you don’t do. For example, you don’t use moving averages extensively. When do you use your indicator and when don’t you use your indicator? That answer comes only with experience, after many years of trial and error.

How much of what you do are you willing to share with others?
I have spent my whole life teaching. I share everything.

If all patterns/indicators/strategies you use are in the public domain, what is it about the way you use these tools that accounts for your superior success?
I don’t know about superior success, but I’ve been in business for a long time, so I must be doing something right. In investing (or trading), you have to be honest with yourself and you have to be flexible. We all make mistakes, but we must not compound our mistakes. In technical analysis, you can correct the mistakes quickly, but you have to have the ability to admit a mistake. People will respect you for doing so. When you’re practicing technical analysis, you have to be totally eclectic, because there will be a time when the approach you’re using doesn’t work. If you’re not flexible, you’ll self-destruct. I don’t believe that any one approach works all the time. When in doubt, always default to price. People debate: “Oh, I’m a volume guy,” or “I’m a put-call-ratio guy.” You don’t own volume, you don’t own put-call ratio—you own price! That’s my dictum. If a trend is going up—I don’t care if it’s going up on light volume—I am with it. If it’s going down, I am with it. I own the price. Not everybody will do that.

How do you deal with the problem of the tradeoff between early signal detection and sensitivity to random noise?
First of all, if you’re a short-term trader—and I’m talking about day to day or couple of weeks to couple of weeks, which is not what I do—you’re more susceptible to random noise. All the firms I worked for—and I worked for three major brokerage firms—invariably told us to have a twelve-to-eighteen-month time horizon, just like the fundamental analysts did. So I don’t pay attention to little jiggles and wiggles. However, being human and having to call market turns, I get fouled up by an erratic move or two, which can distort things. But if you eliminate a lot of noise, it shouldn’t impede or interrupt your long-term outlook. I just don’t do short-term trading. I don’t want to do it, though if I had to, I could, and then I would have to deal with the noise. There will always be noise there. That’s why you use stop-losses to protect yourself.

Is technical analysis more effective when used on its own or when combined with fundamental analysis?
If I were in charge of a portfolio or a mutual fund, I would always start with fundamentals. There would have to be a reason why I want to own a company, but technical analysis would always dictate when and how I would deal with a stock. So under those circumstances, I would want to have both. Now, when you step into my chart room, you’re asking me my opinion, which is one hundred percent technical. When we put out a market letter, it’s a technical market letter. It’s not dictated by any other outside forces except the technical ones. When I go on the road and I’m talking to a large audience, and especially when I’m talking to the public, I try to set up a fundamental case to back my picture, because it’s easier to present a position that way. I can’t just say, “Well, you’ve got to buy this stock; it has a nice bottom.” That doesn’t sell it. I could say that to a professional technical audience, because they would understand that. But for an audience that’s not technically sophisticated, you have to gauge your terms. That’s where the problem with technical analysis lies: It’s not with what we do; it’s with how we say it. We confuse people with our jargon, so I don’t use that language. I use words like overvalued and undervalued instead of tops and bottoms. A base is a stock that is undervalued, and a top is a stock that is overvalued. Believe me, fundamentalists understand exactly what that is.

So your approach is purely technical. You bring in fundamental analysis only when you’re explaining your purely technical approach to a nontechnical audience. Correct?
Yes. At Prudential, I created a unique product. It starts with the universe of fundamental stocks that the firm follows. Out of those stocks, I’ll take only the ones that are graded as buys. Then I’ll ask, “Of these fundamental buys, how many are quantitatively graded positive or negative?” I take that list of fundamental buys, and I run it through the quant screen. Let’s say starting out with five hundred stocks, two hundred are fundamentally attractive. One hundred of them are positive quantitatively. I’ll take that one hundred, and I’ll look at them technically. Maybe seventy-five of the one hundred will look good technically. These stocks now have gone through a triple screen, so I call them “trice blessed”—from fundamental, quantitative, and technical points of view. We do that report once a month. We also have fundamental analysts who have sell ideas. Stocks graded as sells are “cursed.” They may be “twice cursed” or “trice cursed”; that is, they can be cursed from a fundamental, quantitative, and/or technical point of view. Clients love this system because they understand that I’m using all three of the disciplines. Although I’m a technician, I use the other two disciplines before I get to the technical recommendations. So I use other research disciplines, and it’s a very popular product.

Does political or global analysis influence the decisions you make in your chart room?
I have the TV on all the time. I read many newspapers and magazines. I try to follow what’s going on in the real world. We can’t live in a complete vacuum. Does the news change my market opinion? No, my market opinion is technical. Can it have an impact? Oh, sure. Things like presidential cycles certainly can have an impact. We did a whole study on the impact of wars on the markets. When wars start, the market usually goes up. People don’t believe that. That’s all history, and it’s fun. I think technicians make better fundamentalists. You do it backwards, because when you see something on a chart, you’ve got to find out why. A good technician is always asking why.

Why do you eventually share your inventions with others, rather than keeping the edge for yourself?
I don’t explain everything in detail. I explain what I’m trying to do, but I don’t give out the formula. The formula is proprietary, and I tell people it’s a proprietary indicator. It makes it a little mysterious, too. It’s not all that complicated. I do fairly basic technical analysis. Up is good; down is bad. Seriously. I know it’s hard for some to believe that, but it’s true. The trend is most important. People tend to make more out of the subject than it really is. Keep it simple.

How often do you use the technical tools you developed yourself?
As frequently as possible. They’re not trading tools. I might use a particular formula a couple of times a month for a report. My work doesn’t depend on a computer program. If computers all disappeared tomorrow, I’d still be the same technician I am today.

Describe your working day.
I get into the office around seven o’clock in the morning and leave about six. I live nearby. By the time I get there, I’ve already read theWall Street Journal and watched the news on television, all in order to get a feel for what the day might hold in store. By the time I walk into this building, I think I know exactly what the market is going to do. Everything seems perfect. But the problem is, when I get in the elevator, I talk to a few people, and by the time I get off the elevator, I am totally confused because I have to deal with the real world. Right across the hall is the conference room, where I listen to the fundamental analysts at 7:30 a.m. They talk about different industries, and I take notes. I accept everything the analysts say, but when I step into our chart room and close that door, I don’t listen to the fundamentals anymore. I’m religious with my graphs. I wouldn’t buy anything that’s going down, despite what the analysts say. Moreover, I talk with clients and write all the time. Monday, when I do a considerable amount of writing and have two to three conference calls, is the worst day of the week. Traders call here as well, and that’s a minute-by-minute application of charting. The two other technicians are always discussing indicators, market reactions, etc. The ideas are constantly being brought out. At times, the room is quiet as a library because we’re in the research department, and we need time to think.