How to use Technical Analysis

 

When I was first a broker with Dean Witter in the early 80’s, we had a squawk box in the front of our office. Every morning different strategist and analysts would come on to fill us in on their outlooks, offerings or viewpoints. There was a technical analyst named Joe Feshback who would come on and take calls from the field and comment about individual stocks from his chart perspective. Wow was he impressive! He would look up a chart and tell you exactly and confidently what the stock was going to do. I’d been in the markets since the mid 70’s but had never seen this type of guy. It was really great when you were unsure to hear a person boast so confidently what the future would bring. Sometimes he would talk about the general market and what his “indicators” were telling him.

Then came 1987 and the crash in October. The crash itself was Monday 10/19 and the market fell 500 points or over 22%. The week prior it fell every day for a total of 250 points or 10%.

 


Good “ole“ Joe came on throughout the week and continuously told us numerous times that he had never seen the put/call ratio so bullish and that we should back up the truck and leverage the house to buy stocks for this, the opportunity of a lifetime. If one had followed his advice they would have been hurt badly. For the record I didn’t take his advice and sold all my stocks in that previous week – I’d just had enough pain already.

These guys proliferate today in many forms and I’d just like to  tell you some thoughts from my perspective:

Technical analysis attempts to read human emotions and trends through a chart – an admirable exercise. However it’s not the science they make it sound like. If it was they all be coming to the same conclusions based on the same chart, which doesn’t happen. Each one has favorite indicators and ones they don’t like. I’ve never met a technician who got rich through trading. They made money through selling their analysis.

These people can be dangerous because they sound so confident in their analysis that they influence you to act other than you might. That’s your fault, but caveat emptor!

One big reason why I believe these guys fail is that like most other types of analysis – fundamental, etc. – they face the impossible task of identifying all the pertinent indicators and information that pertains to a particular point in time. They can’t identify all the correct variables they know about, let alone the ones they are not even aware of. And what about those Black Swans? That’s the real biggie. They inevitably get tripped up by the “I didn’t see that one coming” or “I’ve never seen that before”.

The way I do use technical analysis is by becoming aware of the “lines in the sand” or levels that they preach about and watch. You know the “1180 is major support and if that fails then... ... ...”. The reason I watch those is because I know that everyone else is also watching them. When the market gets into an important level – let’s take “support” as it relates to this market – people will either get excited because it held and start pushing the market up – or if it fails they will get demoralized and start panicking. This means that that area is a higher risk area and as such I do not want to trade around it because it’s a guess.

These guys fit into two categories:

The ones that say confidently what is going to happen and refer it to as exactly the same game plan from a different time. --i.e. “we are at major support and you should buy now for a move up to 1218.56”. The problem here is the bravado that they espouse, and when or if the unknown variables come out or Black Swans appear, you’re cooked. Useless information but unfortunately they sound like they know what is going to happen.

Then there are the useless wafflers. “1180 is major support and if that doesn’t hold then look for 1168 and then 1155. However it does hold then we can see 1196 then 1207 and eventually 1218.56”. What do you do with that info? It’s the two-handed economist thing. “on the one hand ... ... but on the other hand... ...” You need a one-handed technician.

Stay conservative. It’s dangerous out there!