The First Victory

The efficient market hypothesis states that stock prices reflect everything known about a company, an industry, or the economy as a whole. This simple academic proposition has some staggering implications when you think about it. It implies that stock prices cannot be predicted, that everything known about a stock is already reflected in its price. Prices will only be moved by events that cant be foreseen. The first conclusion the academics drew was that technical analysis is thus useless in predicting future price movements. Bingo. This statement, if accepted, takes out a major part of Wall Street research with one hard swat.

Technicians are survivors. They have been part of the scene almost since securities were first traded. They believe that by studying a myriad of charts, trading figures, and similar indicators they can do precisely what the professors say they cannot-project the past pattern of stock prices into the future to make major profits.

Investors believe them. The pubhc, and even some pros, will treat a well-known technician who makes one or two major calls with an adulation at times approaching reverence. Tens of thousands treated Joseph Granville hke an oracle for making several major market calls in the late 1970s.

Granville modestly acknowledged the acclaim by dressing in the flowing white robes of an Old Testament prophet, and when the spirit moved him, walking on water. (He crossed swimming pools on a glass plank he brought especially for such occasions.) He claimed to be the first person to have "cracked the secret of markets," and could never make a serious error again. Naturally, he believed he would "win a Nobel Prize for this feat." Unfortunately, the gods of the marketplace changed the secret shortly thereafter. Joe dropped to the bottom of the heap over the next fifteen years, according to the Hulbert Service, a watchdog of market letters. Granville was rated last of 20 market timers with a -27.4% average annual return. In this case the professors proved right.

these are winning approaches. All they need is the time and diligence to practice them properly. However, the methods, like the pros performance record, do not stand tall under scrutiny.

Still, almost all current investment methods and practice are based on either the old or the new. But is either really suited to your needs? Well look at that question now.

Hail the All-Powerful Chart

The technicians single most important tool is the chart. The most common form of chart is the bar chart or vertical line chart, illustrated in Figure 2-1. These are normally plotted daily or weekly, though monthly movements are tracked for longer-term perspective. The thin vertical lines in the upper graph indicate the weekly trading range, with the small horizontal tick showing the closing price. The series of vertical lines at the bottom of the chart represents weekly volume. Through the recognition of dozens of different pattems, the all-important trends can be pinpointed.

Trend Unes are essential to the chartist, because of the paramount principle that a trend once started does not easily change course. A change in trend, or a reversal, the technicians believe, can be recognized by diUgent study of the charts. Spotting a change quickly allows them to protect their positions and to benefit from the new market course. This belief is fundamental to the technical method. Technicians have identified large numbers of pattems that clearly indicate, they think, a reversal of course of either the averages or individual stocks. The jargon of the technician is liberally sprinkled with names for the various trend and reversal pattems such as the "head and shoulders" formation, the "reverse head and shoulders" pattem, along with many intricate variations, some with monikers more appropriate to a side show: deformed heads, two heads with one shoulder, and multiple heads and shoulders, to cite a few.

To the pragmatic technician, analysis of price and volume statistics is the key to the direction of price movements. "[The technicians] central thesis is the past is prologue, " wrote my good friend, the late Vartanig G. Vartan, senior financial columnist of The New York Times. "A pure chartist is almost monk-Uke in dedication, believing the essential truth about the market is to be found in squiggles and figures on graph paper. He is unmoved by a plant explosion or a profit explosion."

Technicians believe stocks and the general market move in discernible trends that continue until they clearly signal a change in course. Because stocks never move in a straight line, but invariably retrace a portion of each advance or dechne, the analyst must be able to filter the useful information from the vast amount of static. A technician usually has a favorite method, but will use a number of others to confirm or reject a conclusion.

From Technical Analysis to Astrology 43 Figure 2-1

Intel

9/30/94 - 9/30/96

09/30/94 12/23/94 03/17/95 06/09/95 09/01/95 11/24/95 02/16/96 05/10/96 08/02/96

11/11/94 02/03/95 04/28/95 07/21/95 10/13/95 01/05/96 03/29/96 06/21/96 09/27/96

Source: Prepared from FactSet data

Numerous backup indicators are relied on by sophisticated technicians to confirm their favorite method. Support and resistance levels are two widely used tools. A support level indicates a valley a stock has climbed out of; a resistance zone is usually a previous peak. At a support level, sufficient demand is available to halt a further decline, at least for a time. A resistance zone, on the other hand, prevents further upward movement because enough stock will be sold at that price to halt the rise.

The Star Wars Technicians

The computer has exponentially increased the information available to technical analysts. "Star wars" technology has collected quite a following in the last few years. Neural networks and genetic algorithms, for