Saturday, June 12, 2010

The Need for Technicals in Trading

Several years ago I had a conversation with a private banker about trading. I had been doing pretty well and mentioned that my trading was based on technicals (chart formations). The banker recoiled and said: "You know you can't time the markets or a stock. You need to trade by fundamentals." I asked him whether his bank employed any technical analysts and he said that yes, they did. I asked whether it seemed peculiar to him that if technical analysis was not something worthy of use to traders that his employer employed technical analysts. He conceded that they did have some value, but remained steadfast in his opinion that fundamental analysis was the only solid basis for trading. "If that is so," I asked, "then how do you know when to enter."

A few weeks later we met again and I showed him my trading records and he seemed very surprised and immediately agreed that what I was doing seemed to work. Since that time, and definitely not because of me, through his hard work this fellow became head of the bank's investment department. While I don't really know because we haven't had any recent contact, my guess is that technical analysis plays at least some part in his decision making process.

In a recent article, I discussed the fact that being a good or even a great company does not automatically mean it is a good or great stock. While undeniably appearing to be fundamentally sound, some companies' stock just hasn't performed well over some significant periods of time. A sound company like Exxon Mobil (XOM), for example, has fallen from a high over $95 a share in 2007 to the current price around $60. Procter & Gamble (PG) is below its 2007 high, Alcoa Aluminum (AA) is down approximately $35 from its high in 2001. Boeing (BA) is down more than $40 a share from its 2007 highs. Does that mean that those are not good companies? Certainly not. It only means that the share price is down from some previous point. However, we must remember that someone bought shares of each of those companies at the top. Perhaps the decision to buy at that time was based on a fundamental evaluation, perhaps not.

In the "old days," five or ten years ago, many investors made their investment decisions based on a phone call from their broker in which the broker would tell a story about a company and its fundamentals along with a prediction of where the broker guessed the price would go. In my experience, at least, there was no thought at that point as to whether or not the entry was technically justified or where an initial exit would be in the event the advice proved wrong. Buy and hold was the watchword. Over many years the buy and hold strategy could work quite well provided the investor had an unlimited time horizon with no need for the money. As I have often said, buy and hold is great -- for your heirs.

While fundamentals may offer an answer of what to buy they give little, if any, information on when to buy it. Technicals can provide helpful information on the "when" and can also be particularly helpful in setting an initial exit strategy in such a way that losses can be cut early if the play goes the wrong way. For example, a trader might like a particular stock and can see that it is dropping in price toward some moving average. Let's say for the example that XYZ is moving down toward the 50 day moving average. While we may like the company, the fact is that the stock price is falling. Is that the time to buy shares? Trying to catch a falling knife is one way traders refer to such an entry. On the other hand, how might it be to wait and see what the price does when it gets near the 50 day moving average? Might a bounce up from that average provide an entry and once entered, might a break beneath that same moving average provide an initial exit strategy? If one were to use that technical (the moving average) as described, would it provide a disciplined reason to enter as well as a disciplined exit strategy? Is that better than just "winging it?"

I use technicals because they do provide a disciplined approach for me helping to remove the emotions. Without the use of such a disciplinary device, I wonder how one sets up a trade to accomplish two of the major criteria of successful trading -- cutting losses and letting profits run.

Just as an aside, I now include my 5 DVD (full two day seminar) Stockmarket Weapons and Tactics as part of any personal one on one coaching session I do. I also guarantee satisfaction with the coaching session offering a full refund to anyone who is not completely satisfied and cancels the session after the first two hours.

by Bill Kraft, Editor
Copyright 2010, Makin' Hay, Inc.
All Rights Reserved

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Anonymous said...

I know you're absolutely right about using technical analysis (TA)for deciding on entries and exits.

Can you list two or three books that you consider to be really good for learning TA?

~ Nona

Bill Kraft, said...

Thanks for writing, Nona. A relatively new book, "Technical Analysis," by Charles Kirkpatrick and Julie Dahlquist is excellent as is Martin Pring's "Technical Analysis Explained: The Successful Investors Guide to Spotting Investment Trends and Turning Points." John Murphy's "Technical Analysis of the Financial Markets: A Comprehensive Guide to Trading Methods and Applications" is another fine work. Achelis' "Technical Analysis from A to Z" is quite helpful as a basic resource defining technicals. If you are interested in Japanese candlesticks (I sure am), I recommend Steve Nison's "Japanese Candlestick Charting Techniques" and his "Candlestick." Steve also has a couple of DVD courses that I highly recommend and that I used to distribute for him back when I was doing seminars on technical analysis. Hope that helps.
Bill Kraft

Anonymous said...

Thanks for the recommendations.

I've heard Steve Nison speak and like candlesticks too. I want to get better at understanding and using them -- and everything else.

Learning never ends....

~ Nona