Tscm_1The latest "Apprentice Investor" column is up at TheStreet.com. Its called  "Tracking Elephants, Part I." 

Don’t be fooled by the title to this piece: "Tracking the Elephants" could just have easily been named "The non Technicians Guide to Technical Analysis (in two parts)." The idea was to reveal to fundamentalists a few of the more significant ways they can use charts to improve their results.

Podcast:

Here’s the ubiquitous excerpt:

"Here’s an interesting question: If you could look at one and only one source before buying your next stock, which would you choose: a fundamental analyst’s report (with no charts in it), or the chart of your choosing?  While I like having access to both, I cannot ever imagine buying something without first looking at the chart.

And so we wade into the ongoing battle between technical and fundamental analysts. Frankly, it’s one of the sillier debates in investing. But I’ve heard so many bad arguments and misleading theories about technical analysis that I decided to weigh in."

Before we wade too deeply into the controversy, ask yourself: "Why do I need to choose?" Why wouldn’t you use any tool that can be shown to have value? You wouldn’t build a house using only a hammer, but no drills or saws. Why limit yourself away from a tool that can assist you as an investor?

In the column, I used a chart of Ford — but it could have been just about any company , from JDSU to Lucent to World Con or Enron.
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Ford’s Downtrend
click for larger graph

Fordaiannotated

Prior columns can be found here.

To keep the column a modest length, a discussion about Janus Funds
selling of AOL Time Warner was edited out.  For your reading
pleasure, that section is here.

Podcast:

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Here’s a DVD extra scene which did not make it into the final cut of the film:

"As we discussed earlier, institutional size positions can take months or even years to unwind. A downtrend is nothing me than the footprints of that distribution in chart form.

A specific example may make the point clearer: When AOL merged with Time Warner, it created a problem for several mutual funds, especially for Janus Funds. At the time, they were one of the largest shareholders in both companies. Many of their mutual funds had significant positions in each. The merger meant that one company would be disproportionately represented in various portfolios. Typically, funds put a cap on positions: They do not want any one company to grow to more than 5% of the portfolio.

click for larger chart

Aol_twx_chart_1

Suppose a fund owned 5% of Time Warner and 5% of AOL. The combined company would become 1/10 of the fund. That single outsized holding could defeat some of the purposes of actively managed funds — diversification, lower volatility and reduced risk.

After the merger, AOL Time Warner had about 4 billion shares outstanding. Some estimates put Janus owning (across many of their various tech funds) nearly 25% of the outstanding shares of the combined companies. You could just imagine the conversations that took place at that time. This concentration simply wouldn’t do. So Janus made the rational decision to reduce their exposure to AOL Time Warner.

Here’s why they call it distribution: AOL trades about between 5 and 10 million shares a day. If the fund’s selling made up half of the daily volume – a huge percentage — it would take 200 trading days (about 40 weeks) to sell a billion shares.

Who wants to step in front of that sort of relentless selling? Unless you knew when the distribution was ending — and you can see why institutions try to keep this secret — you were nearly guaranteed to be upside down almost immediately.

That’s the first and most important lesson of technical analysis: stocks that are trending down are likely to keep going lower as institutions continue to distribute shares.

The same rules apply in the jungles as they do in investing: Do not get trampled by the elephants.

Category: Markets, Podcast, Technical Analysis

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

3 Responses to “Apprenticed Investor: Tracking Elephants, Part I”

  1. fester says:

    If I am understanding you correctly, especially in the DVD extra section, a novice investor with rational ignorance and limited capability for information investment should be a smart momemtum trader, and give up a little bit of upside potential (not buying in a downtrend) in order to signifciantly reduce downside risk by letting the chart first flatten out and then start moving out and above the down trend and at that point jump into a stock?

  2. Novice investor says:

    What are the most common technical indicators. I look at that chart and say great – but I could never draw it myself.

    Is there software available for a T.A. novice? How does one choose which TA indicators to use? What are the most common?

    Thanks in advance.

  3. tim k says:

    FYI for novice investor:

    check out Stockcharts.com. charting, tutorials, market scanning tool. modest free resources, reasonably priced extended featutes. for books: Martin Pring and Steve Nison discuss chart and candle patterns, John Murphy on intermarket relationships in technical analysis. Douglas on traders’ psychology. I use bollinger bands, moving averages, price oscillators, and trend indicators like Wilder’s DMI. simplest is usually best. losing trades are the tuition price for your education. accept that occasional bad trades are part of trading as well as baseball, and manage your money. control your losses, preserve your capital. I’m a short term swing trader. I use a modified “Kelly formula” for money/trade management analysis. (google search it). increasing your knowledge of the markets and trading techniques, and indicators, is important. once you’ve gotten the basics, even more important is what’s going on in your head. the steering wheel doesn’t drive the car, the driver does. all the indicators in the world won’t protect a trader whose judgement is impaired by fear of losses, excessive greed, or careless analysis. the trader is part of the trade. Douglas (“Trading in the Zone”) has useful things to say. Read Barry’s “Apprentice Investor” columns here and on thestreet.com. he makes a lot of sense. Good luck!!