July 23, 2011-Sharpening the Mind – Educational Chronicles #1 (A First of Many)

Actually, this isn’t a book review, but more like a “Cliff Notes” study review.  This represents the first of several notes that I intend to publish, in an honest attempt to put my education in technical analysis in a structured format.  I will devote a separate menu and header for easier visibility.  I will be employing the use of the recommended readings presented by Market Technicians’ Association to its Chartered Market Technicians students.

Below are my highlighted notes, chapters and pages as I study them in preparation for trading successfully in the markets.  If by any way, this helps you, just pingback/comment and I’ll definitely try to linger more on these topics.  I believe in online study groups.  Your feedbacks are most welcome.  If you so like, you can also follow my reading schedules.  I’m going to focus on 3 technical analysis textbooks at least for the next 2 months, with in depth notes and “flashcards” in order to make the wisdom of the ages more accessible to everyone.  My hope is that you will have more thirst in understanding and interpreting the graphic formations better, in order to trade better.  Arming yourself with knowledge, will enable you to act appropriately in the markets.

Readings:

1.) Pring, Martin J., Technical Analysis Explained, 4th Edition.
2.) Edwards, Robert D. and Magee, John, Technical Analysis of Stock Trends, 9th Edition
3.) Kirkpatrick, Charles D. and Dahlquist, Julie R. Technical analysis: The Complete Resource for Financial Market Technicians

(If the site is still up, you can download free copies of books 1 & 2 from traders library.  For 3, I personally had to buy Kirkpatrick from Amazon as I can’t find any torrents for this book.)

_____________________________________

Reference: Pring, Martin J.  Technical Analysis Explained (4th Edition) . Preface & Introduction 

1.) Traders and investors are creatures of habit who react and often overreact in predictable ways to rising or falling stock prices, breaking business news, and cyclical financial reports.  Technical Analysis is the art of observing how investors have regularly responded to events in the past, and using that knowledge to accurately forecast how they will respond in the future.

2.) There is no reason why anyone cannot make a substantial amount of money in the financial markets, but there are many reasons why many people will not.  As with most endeavors in life, the key to success is knowledge and action.  While this book seeks to illumine the internal workings of the market, action (patience, discipline and objectivity) is left to the individual investor.

3.) To be successful, technical analysis should be regarded as the art of assessing the technical position of a particular security with the aid of several scientifically researched indicators. 

4.) There is no substitute for independent thought.  The action of the technical indicators illustrates the underlying characteristics of any market, and it is up to the analyst to put the pieces of the jigsaw puzzle together and develop a working hypothesis.

5.) The task is by no means easy, as initial success can lead to overconfidence and arrogance. 

6.) Pride of opinion caused the downfall of more men on Wall Street than all the other opinions put together – Charles Dow.

7.) Markets are essentially a reflection of people in action.   As investors react to the constant struggle through which the market will undoubtedly put them, they will also learn a little about their own makeup. 

 8.) Little minds are taxed and subdued by misfortune but great minds rise above it. – Washington Irving

Advantages of Market Timing Approach Versus Buy and Hold Approach:

In practice, it is impossible to buy and sell consistently at exact turning points, but the enormous potential of this approach still leaves plenty of room for error, even when commission costs and taxes are included in the calculation.  The rewards for identifying major market junctures and taking the appropriate action can be substantial.

When holding periods are lengthy, it is possible to indulge in the luxury of fundamental analysis, but when time is short, timing is everything.  In such an environment, technical analysis really comes into its own. 

Major Technical Principle : Technical Analysis deals in probabilities, never certainties. 

The art of technical analysis, is to identify a trend reversal at a relatively early stage and ride on that trend until the weight of the evidence shows or proves that the trend has reversed.

Technical analysis is based on the assumption that people will continue to make the same mistakes they have made in the past.

Three Branches of Technical Analysis:
1.)    Sentiment
2.)    Flow of Funds
3.)    Market Structure Indicators

Sentiment Indicators– monitor the actions of different market participants (insiders, mutual fund managers and investors, floor specialists)

*Advisory services are consistently wrong.  Insiders and major stock holders of the company have a tendency to be correct at market turning points.

Flow of Funds Indicators – analyzes the financial position of various investor groups in an attempt to measure their potential capacity for buying or selling stocks.

Buy side – pension funds, insurance companies, foreign investors, bank trust accounts, customers’ free balances

Supply side – new equity offerings, secondary offerings and margin debt

A Superior approach to flow of funds analysis is derived from an examination of liquidity trends in the banking system, which measures financial pressure not only on the stock market, but on the economy as well.

Market Structure Indicators- these indicators monitor the trend of various price indexes, market breadth, cycles, volume and so on in order to evaluate the health of the prevailing trend.

Classification of Price Movements
1.) Primary – major movements (1-3 years), reflection of investors’ attitudes toward the business cycle.
2.) Intermediate -6 weeks to many months
3.) Short term- 3-4 weeks, tend to be random in nature

Discounting Mechanism of the Market

1.) All price movements have one thing in common.  They are a reflection of the trend in the hopes, fears, knowledge, optimism and greed of market participants.  They are never what they are worth, but what people think they are worth. – Garfield Drew.

2.) The stock market consists of everyone who is “in the market” buying or selling shares at a given moment, plus everyone who is not “in the market,” but might be if conditions were right.  In this sense, the stock market is potentially everyone with any personal savings.

 

It is this broad base of participation and potential participation that gives the market its strength as an economic indicator and as an allocator of scarce capital.  Movements in and out of a stock, or in and out of the market, are made on the margin as each investor digests new information.  This allows the market to incorporate all available information in a way that no one person could hope to.  Since its judgments are the consensus of nearly everyone, it tends to outperform any single person or group.  – Wall Street Journal.

3.) A bear argument known is a bear argument understood.

Financial Markets and the Business Cycle

1.) Major movements are caused by longterm trends in the emotions of the investing public.  These emotions reflect the anticipated level and growth rate of future economic activity, and the attitude of investors toward that activity.  There’s a definite link between primary movements in the stockmarket and cyclical movements in the economy because trends in corporate profitability are an integral part of the business cycle.

Why is the task of determining the changes in primary movements not simple?

1.) Changes in the direction of the economy take time to materialize.

2.) Psychological considerations can result to misleading rallies and reactions.

3.) Changes in the market usually precede changes in the economy by 6-9 months, but the lead time can sometimes be far shorter or longer.

4.) Doubts of durability arise during an economic recovery.  Doubts can lead to sharp and confusing counter cyclical price movements to develop.

5.) Profits may increase, but investors’ attitudes toward those profits may change.

6.) Technical Analysis approach is no means infallible, but a careful patient and objective use of the principles can put the odds of success very much in favor of the investor or trader who incorporates these principles into an overall strategy.

 

-The Faceless Trader

 

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3 Responses to July 23, 2011-Sharpening the Mind – Educational Chronicles #1 (A First of Many)

  1. marvin says:

    Hello Faceless Trader! Sir, is Investment Psychology Explained same with Technical Analysis Explained by Martin Pring? Can’t find the later in traders library. Thanks!

    Like

    • hello marvin, no- It’s not the same. Investment Psychology explained is another book by Martin Pring I think that is equally a best seller among the traders’ community. I don’t have a pdf copy. I just borrowed mine from a friend. I’m not sure if there are copies in National Bookstore, if you’re willing to look for it tlga. I’ll try to summarize my learnings, and if it’s fine with you— un na lang muna kung tlgang walang mahanap na torrents for it. If by any chance, mahanap mo though, do send links here to help others who are reading this blog 😀 – FT

      Like

      • marvin says:

        FT, it’s fine with me, of course. Thank you. Anyway, I read the introduction of Trading Psychology Explained and I find it interesting too 😉

        Like

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