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November 1996
If you've read STOCKS & COMMODITIES for a while, this may come as no surprise: The purely technical trader believes that the price action tells all, that any other information simply does not warrant consideration. Why? Because the market itself, reflecting the combined opinions of the best-informed participants, is considered the best source of information. And what information are we looking for? The trend, of course!One tenet of technical analysis is that a trend, once in motion, will persist. The trend, which is driven by the fundamentals, will end when the market itself decides it should end, and not before. Trends have beginnings and ends, and technicians have methods such as price patterns and indicators to identify breakouts of bottoms and tops. There's nothing much here that's new, but keeping an open mind is crucial; with the marketplace being such a competitive environment, I propose taking a hard look at a blend of technical analysis and fundamental analysis, called quantitative analysis. The value of this approach is a topic of discussion in this month's S&C interview with money manager and author James O'Shaughnessy.
O'Shaughnessy discusses some of his findings published in his most recent book, What Works on Wall Street. The book is excellent, detailing research into the performance of various portfolios of stocks with predefined characteristics and comparing the returns to an index. High relative strength -- that is, the individual stocks' price performance relative to the market -- is one of the consistent indicators of top performance by the portfolios. Other criteria are equally important, but the relative strength approach is a technical method and certainly supports the earlier discussion of the technical tenet regarding the trend. As you read the interview, you'll find more perceptive and intriguing thoughts from O'Shaughnessy, including his opinions about crowd psychology and the importance of having a disciplined approach.
But then, trading stocks isn't for everyone. Your focus may be the commodity markets. If so, then you may want to give Robert Krausz's "Dynamic multiple time frames" a read. Krausz, who was profiled in Jack Schwager's New Market Wizards, presents a method for analyzing the commodity markets. He explains how to set up support and resistance levels and identify the direction of the trend as well as market reversals, using a higher time frame for your trading. If you're an intraday trader, for example, you would use daily market activity for intraday trades, or if you only look at the markets in the evenings, then you'd use a combination of daily and weekly data.
Today, technical analysis incorporates a vast parade of approaches. The approaches range from sophisticated analytical methods using the most modern, powerful computers to the tried-and-true classic methods such as chart patterns. Here's a case in point. Compare, if you will, these two articles in this issue: Thomas Bulkowski's "Ascending and descending triangles" and Jeffrey Owen Katz and Donna McCormick's "On designing trading systems." Both articles offer useful information to two very different audiences with very specialized interests in technical analysis. But that's why we're here each month, to offer our readers the widest range of subjects in technical analysis. Hopefully, you'll learn the techniques that suit you best and make the markets an easier place from which to profit.
