Relationship Investing
Page 2
The technical analyst, on the other hand, isn’t interested in the news but rather in the stock’s or market’s response (that’s the key word) to this news in terms of their price movements relative to a variety of supply-demand tools. These movements, which can be measured on an intraday, daily, weekly, monthly, quarterly, or even yearly basis (or variations thereof), form price patterns over time that, among other things, the technical analyst attempts to successfully interpret.
My strong personal belief (to put it mildly) is that if I want to try to predict the future movement of a stock, I’m going to follow—you guessed it—the stock, not the company. Repeat, not the company! Why would I want to analyze the company when it’s the stock in which I’m investing my hard-earned capital? If I were investing directly in a company then it makes sense to me to analyze that particular entity, but not when it’s shares of stock in which I’m interested in investing. In those cases I want to go right to the source where my money is being deployed. Think of it like this: let’s say you’ve met someone whom you’d like to ask out and get to know better. Would you ask out her siblings or other family members to do this, or would you go straight to the source of your interest? I think you get my point.
Remember that when a “margin call” (an obligation to add capital to an account in instances where money is borrowed from the brokerage firm and the account value dips to a certain level) is received that it’s based purely on “technical” (price) considerations. The fundamental condition of the underlying companies—no matter how stellar they may be—play no role. Think about that. You can own shares in the most prestigious companies in the universe, with uninterrupted streaks of rising earnings and dividends and a product line and management team second to none, and still receive that dreaded margin call.
Don’t forget that the market’s overall trend exerts a powerful influence on its component issues—thus, the popular saying that “the trend is your friend.” Lots of money has been made purchasing the shares of poor companies, just as generous amounts of capital have been lost buying the shares of great companies. Since the majority of issues are going to move in the direction of the primary market trend, beginning with an analysis of the individual company doesn’t make much sense. Unfortunately, this key investment fact (like so many others we’ll discuss herein) doesn’t receive nearly the attention it deserves. Hard-working and devoted Wall Street analysts spend countless hours analyzing loads of corporate data and company trends to arrive at an investment conclusion, when in fact it’s the market’s major trend that will decide the underlying stock’s direction in many, if not most, cases.
Never forget the importance of respecting the market’s primary trend. Investing is not as simple as finding a great company, purchasing its underlying shares, and waiting for profits to materialize. Not to the technical analyst. If that were so, you wouldn’t have legions of disappointed investors year in and year out.
But while I’m a technical market analyst, utilizing tools like trend lines, moving averages, pattern recognition, market breadth, varying time frames, divergence analysis, and reversal analysis (among others) to make my investment determinations, I must stress at the outset of this book that no matter what your investment discipline is, the truest measures of its worth are as follows:
1. Does it address market risk and capital preservation considerations?
2. Are you satisfied with the resulting track record?
3. Can it aid in getting you out of a position prior to a serious decline?
I have many friends and acquaintances from across the market spectrum—both technically and fundamentally investment oriented. No matter what discipline they choose to utilize, my hat’s off to anyone with a respectable track record achieved with the highest moral and ethical standards. There are wonderfully gifted fundamental analysts out there, far smarter than I’ll ever be. It’s just that I can’t look at reams of corporate financial data and have any idea what that offers me in terms of correctly gauging the movement of stocks or the market in general.
It’s like having all the statistical information and performance data on a car you’re interested in buying but still not knowing how it will drive. Looking good on a statistical basis may not accurately reflect how it will perform. Road conditions are also an important consideration in that regard. If they’re treacherous, the financial equivalent of which is a primary bear market for stocks, you’ll want to avoid traveling on both no matter how good your “vehicle” looks.
Relationship-wise, how often have you felt someone seemed like a potentially great match after reviewing his interests and other pertinent information “on paper,” only to conclude after meeting him in person that the match wasn’t meant to be? Just as there’s no substitute for interacting with someone face-to-face to thoroughly assess them and draw a personal conclusion, you need to view the action of the stock and overall market by directly observing their respective price movements to arrive at an investment decision. Any other way places distance between you and the market. That’s how a technical analyst thinks.
This book is not intended to tell you which individual stocks to buy or sell, but more importantly to suggest some key rules and insights that comprise an investment approach and philosophy which you, the investor, can use for the rest of your investment lifetime. In fact, some of your very own life experiences should come in handy when considering a potential course of investment action. That’s why I chose the title Relationship Investing. By using life experience as the common denominator, I believe that I can assist in simplifying the process of making difficult investment decisions while simultaneously relating to the largest possible pool of investors. Hopefully, you’ll be able to achieve potentially improved investment results while better addressing market risk. Remember, the stock market is both judge and jury, and its verdict is final. Like it or not. Period!
You’ll also notice as you read this book that, in certain instances, I stress the same point in slightly different ways. I think these tenets are well worth repeating on those occasions. Some of the long-held market beliefs I’ll be questioning will surprise you, but my fiercely independent nature does not allow me to accept something as fact merely because it has been repeated over and over and over again and a large contingent of pundits believes it to be so. Besides, I think some of these widely accepted market “truisms” are just plain wrong and potentially financially dangerous, as I discuss herein.
I hope beyond hope that by reading this book you’ll be better armed to compete in that huge, volatile arena known as the stock market. I’ve seen more market participants financially hurt over the years than I care to remember. I’ve listened to their stories of financial loss and seen the expressions of exasperation and concern on their faces. If I can assist the individual investor by authoring a book that “tells it like it is,” using life’s experiences to help simplify the Wall Street maze, then I have taken a step toward repaying the many investors, analysts, brokers, and caring friends who have helped guide and support me over the years along the market’s always-tricky path. I’ll never be able to thank them fully.
And make no mistake about it: I’m speaking from the standpoint of a technical analyst, practicing a market discipline I believe offers the most well-rounded investment method. In my world, analyzing the underlying company will never be a viable substitute for analyzing the price movements of the stock when formulating investment decisions. It’s just my personal view, but one that I’ve adhered to successfully for decades.
Chapter 2
Relationship Investing
I have always believed that you must treat your investments in the stock market as you would treat a personal relationship, and this is the central theme of my book: relating the stock market to relationships in your life. For example, if a couple is dating for a period of time and their relationship sours to the point where they can’t stand one another anymore, are they going to get engaged, marry, buy a house, and have kids together? Of cours
e not! The relationship would be severed immediately. But what seems like such a clear-cut choice in life is often far murkier when it comes to investing in the stock market—where money, egos, and emotions can combine to do funny things to people and make them act in ways often detrimental to their investment health.
For example, time and time again the worse a desired stock acts and the cheaper it gets, the more excited some market participants get about owning it. Not only do they establish new positions in the shares, but those who already own the stock at higher quotes commit an even greater investment sin: they “average down” the already losing position (meaning they buy additional shares as it declines in price). Unfortunately, the result that this “buy more when it acts poor” strategy usually achieves in declining markets is a compounding of losses and extra tax loss carry forwards at tax filing time. Again, it’s like dating that person with whom you have nothing in common, really can’t stand, and argue with frequently, yet propose to, marry, purchase a home, and have kids with. It’s almost as if you need to justify remaining in a poor relationship or holding a losing equity position on the grounds that you’ve already got so much time or money “invested” in that endeavor. It’s a bad excuse, however, and offers nothing constructive in terms of reversing those negative situations. You need to know when to sever a relationship, whether it’s personal or monetary or business related.
I also realize there’s an aversion to adding to an equity position as it rises in price, fearing that you’re either paying too much or buying the position at what will prove to be at or near its price peak. But in keeping with our relationship investing theme, if you purchase a stock and it proceeds to rise, the market is proving your thinking correct so far. Aren’t you then wiser to consider buying more shares of a stock that’s confirming your viewpoint and rising in value (and most importantly in this author’s view, acting well from a technical analysis standpoint) than in adding additional, hard-earned capital to a stock that’s showing you a loss? This type of investment thinking also helps significantly when it comes to risk management considerations and the setting of “stops” (predetermined orders to buy or sell a security, which I’ll discuss later). Selling your stock market winners only because they show you a profit is like refusing to continue dating someone whose company you thoroughly enjoy. Why sever a potentially winning relationship? It’s like telling that person “things are going well, we’re getting along and enjoying each other’s company, so let’s break up.” Penalizing either just because they’re showing positive results makes no sense. While there are reasons you might want to pare a profitable stock position—such as a potentially weakening chart pattern—unease with it comprising too large a portion of the portfolio’s value, or some other consideration, to use the fact that it’s showing you a profit as the sole criteria for its sale isn’t part of this analyst’s discipline.
You’re far better off taking the time to analyze your errors so you can try to correct them than in putting a lid on how good something can get. So spend plenty of time analyzing and revisiting your losing trades because, as with a relationship, ignoring your mistakes won’t make them disappear. In fact, it only assures their continuance. Unfortunately, this task isn’t practiced enough. Remember that a stock must prove itself worthy of attracting your hard-earned investment capital for purchase. It does that by acting well overall, not poorly.
Make no mistake about it; investing is a difficult business. It tries your patience and tests your emotions. In many cases, simply accepting the conventional market wisdom doesn’t work. By relating situations in the stock market to those in our everyday lives, I find that people have a common denominator that assists them in the always difficult task of investment decision-making.
Moral: By comparing the stock market’s ups and downs to equivalent situations in our everyday lives in areas like dating, marriage, parenting, and business, you’ll be better able to relate to the tenets of technical analysis in nontechnical terms. This should help you become more closely aligned with the market’s rhythm and remove some of the complexity and anxiety from the investment process. There’s obviously considerably more detail to the business of investing than implementing this technique, but I think it’s a highly useful initial step in beginning to alter, and hopefully improve, your investment approach.
Chapter 3
The Greatest Analyst of All
Let me come right out and say it loudly and clearly. The greatest expert on the stock market is not an economist or a professor or a mathematician. It’s not a securities analyst or a fund manager or an engineer. The greatest analyst of all is the stock market itself, and it pays to heed its movements and its message. As a technical analyst (also known as a market technician), my job is to serve as a stock market translator, so to speak. I try to decipher the market’s message by studying a variety of price graphs and other investment gauges to determine whether money is flowing into or out of the shares or indices or markets in question, whether it be on a shorter-term or longer-term basis. I’m basically taking the markets’ supply-demand pulse, and the tools of my trade function like a doctor’s stethoscope, listening for an internal rhythm.
Since the 1970s, a pen and paper have been two of my primary tools, as I prefer to personally write down market data on both a daily closing and weekly closing basis. I spend ten minutes or so on the former each morning, and around fifteen minutes on the latter over the weekend. I also jot down a few monthly closing figures, which takes even less time. In an age where technology rules, I like keeping this tradition I learned as a kid. It immerses me in that analytical moment. The lion’s share of my time, however, is spent utilizing the wonderful computer graphics and technical market studies available today.
When it comes to believing the verdict of either the stock market or an individual (no matter how brilliant that person is) in assessing an investment trend, I’ll always side with the former. How you decipher the market’s message is up to you, but I’ll tell you this: you cannot successfully invest in the stock market on the “long” (buy) side during a primary downtrend, just as you cannot afford to be left behind during a primary market upswing. It was Charles Dow who identified three trends among the market indices and compared them to the ripples (shorter term), waves (medium term), and tide of the ocean. The last was compared to the long-term trend, which you cannot swim (or invest) against. And so it is with the stock market. Respect its verdict because it reflects not what people are saying with their words but what they are doing with their capital. It’s the same with a relationship—actions speak louder than words!
A single person’s opinion, no matter who that person is, cannot carry anywhere near the same analytical weight as the collectively vast money flows into and out of stocks by the world’s market participants. These money flows form the price patterns that I, as a technical analyst, seek to successfully interpret on my stock market charts. I can’t tell you the multitude of times in which a sustained market move either up or down has been accompanied by cries that the market is ignoring reality or moving in an irrational manner based on the prevailing news background. The truth is that the folks who utter these phrases are ignoring reality, as the stock market is both judge and jury and its verdict—the prevailing market or stock price—is final.
Remember that the stock market is a discounting mechanism, so all too often the reasons why stocks or markets are trending in a sustained direction may not be apparent at the time they are doing so. Witness the market’s substantial liftoffs in the summer of 1982 from an approximate sixteen-year trading range amid little euphoria, from its October 1990 bottom amid widespread pre–Gulf War worries, and in early 1995 with the Orange County, California, bond crisis fresh in investors’ minds. And in case you’re wondering about what’s commonly referred to as the “subprime” mortgage crisis that began in 2007, the popular bank indices peaked early that year, well in advance of both the Dow Jones Industrial Average and Standard & Poor’s 500 Index peaks that O
ctober. Indeed, the market was sounding a warning about this sector well in advance of the analytical consensus.
To the technical analyst, successful investing requires that we learn to listen to the market’s voice first and foremost, not the cries of the consensus or what the so-called expert wisdom says. The technical analyst is concerned only with gauging the supply–demand credentials of a stock or market move—not trying to explain the reasons behind it. The latter is a fundamental consideration. Besides, by the time the reasons for a sustained move in either direction become apparent, who knows where the market or stock will be trading?
Moral: Don’t be quick to dismiss a sustained stock market move in a particular direction simply because there’s an absence of supporting evidence accompanying that move. Rarely are there reasons to account for these rallies or declines at the time of their occurrence, so if you’re looking to make sense of the market’s mannerisms in this way, prepare to be frustrated. History is replete with instances that confirm this. Remember, no one knows more than the stock market does, and disrespecting its verdict can prove financially ruinous.
Chapter 4
Why Technical Analysis?
The stock market and life’s relationships are inextricably linked. They always have been and always will be. Throughout stock market history, investors’ habits have remained intact. Their psychological investment profile is largely unaltered, and so is their response to the market’s movements. Whether it concerns gains versus losses, dividend yields, tax considerations, buying and selling strategies, or so many other investment variables, investors’ thought processes really haven’t changed over time. That’s why the investment tenets mentioned in this book were as valid decades ago as they are today and will be in the future. That’s why the same chart patterns that manifest themselves today and will occur going forward also existed back then. It’s called human nature.