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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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You will still be ahead of the millions of investorsTOOLS FOR MEASURING BEAR MARKETS I have always thought, that if . . . even in the very presence of dizzily spiraling [stock] prices, we had all continuously repeated, two and two still make four, much of the evil might have been averted. Similarly, even in the general moment of gloom in which this foreword is written, when many begin to wonder if declines will never halt, the appropriate abracadabra may be: They always did. Bernard Baruch in July 1932, the month of the absolute bottom of the 1929 crash. Quoted by Andrew Tobias in his Foreword to Extraordinary Popular Delusions and the Madness of Crowds, by Charles Mackay, Three Rivers Press, 1980 Tools to Help You Recognize and Survive a Bear Market We have more ability than will power, and it is often an excuse to ourselves that we imagine that things are impossible. Rochefoucauld, 1665 Its not necessary to debate the merits of the fundamental approach versus the technical approach to justify this chapter. If you like to judge stocks on the basis of fundamentals (earnings, cash flow, book value, corporate officer changes, news of new products, estimates of future earnings, and so forth), thats fine. It does not detract from the technical approach, which generally can paint a bigger and more time-related picture. Many people use both. THE FUNDAMENTAL APPROACH But, if you rely only on fundamentals, you never know whether you have all the necessary facts to make an informed judgment. Some are purposely hidden, withheld, or delayed. Others just may not come to your attention. You have to read everything in sight to make sure that you are not missing a revised estimate of earnings, or a news story about the death of the board chairman, or a new government contract, or news about the order backlog or a contract cancellation. And if you use the Internet for research, false rumors are intentionally circulated to enable criminals to capitalize on the reaction to rumors. THE TECHNICAL APPROACH The beauty of technical analysis is that it is scam proof. It relies on your ability to read the charts and the price data, not on public or insider information. With the technical approach, you know that what you know about a specific index reading is all there is to know. There is no more. Nobody can con you and you can be sure nothing has gotten by you. The price is the price. Follow the money. There may be many ways to interpret each index figure, and new technical indexes and measurements are ever being devised, but the fact remains that once you look at, for example, the low-price-stock-index figure for this week, you know all there is to know, statistically, in that area. There is a satisfaction and mental peace in this knowledge, not to mention a safety factor. In this chapter, I deal only with that part of the technical approach involved with tools, which means methods of measurement of various things in the stock market deemed worth measuring. New tools are being fashioned every month in an attempt to make more of a science of the art of investing. And computer buffs delight in finding ever more sets of numbers to crunch. But my best advice is to use a number of tried and true tools. Examine each new one as it comes along. If a new one appears to add something to the mental picture your existing tools provide, add it to your toolbox. But stay with several tools you get to know, like your family, year after year. That way you come to have a feel for the way each one handles in every kind of market. KNOW YOUR TOOLS INTIMATELY Its usually better to know a tool welleven though you may surmise its not the best tool availablethan to use a great many tools that time prevents you from getting to know one tool like a friend. Its like an artist with an old brush. He knows there are better, newer brushes, but he knows what he can do with the old one. He knows its idiosyncrasies. And every tool has those! Some people believe that a minimum of market tools is desirable, like two or three. Or even one. But the danger here is acute. If you only rely on one like, say, the Mutual Fund Cash/Assets Ratio, you will eventually learn to your sorrow that there are times when this (or any) tool just doesnt work. Even the use of two or three tools doesnt set things right, because often tools are silent and fail to say anything, and if you have silent tools and one is giving a false clue, you are better off with none. Thus, its best to use as many indicators, or tools, as you can handle. But make sure you really understand them; to have so many tools that you have no time to review and develop them lowers their overall value. YOUR OWN PERSONAL INDEX OF MARKET ACTION By putting all your indicators and tools together and having each one vote each week with a weighted vote (based on the past performance of each), youll get a big view of the market. Weighting the indexes is a tricky job, both time-consuming and difficult of appraisal. Yet, it must be done. You may find a better approach than I use, but heres my method: Study an indicator over as long a period as possible. Note how dependable it was in previous bull or bear swings. Calculate what percent of the time it was right. Thus, if it was 85% accurate, it could be given a weight or vote, of say four points on any future occasion when it gives a similar cue to those of the past. If it has a current reading only approaching a normal cue level, you may decide to vote it this week with a weight of only two points. Also, its probably best to vote your indicators in two ways: (1) the actual number of indexes voting plus or minus, and (2) the total points (or votes) cast by the indexes, according to the weights you have assigned them. When points and number of indexes are both positive or negativeand by a safe marginthen market direction is clear. If they conflict or are nearly even, the safe course is to wait. Also, you can vote each index by time categoryshort term, medium, and long. Set up your own premise for how long is short term (to you), and so forth. It makes no difference how long it is, so long as you understand it and interpret everything by those standards. Just how good your composite index will be is up to you. You will have your own versions, concepts, preferences, and experiences. It would probably be impossible to give a formula for a total personal index even if we had a full book just for that. So, in the limited space I have, I can only skeletonize. But, however simple you make your personal index, you will still be ahead of the millions of investors who got into the market during the latter part of the 1990s with little or no idea of how to measure market strength or weakness and who have substantial losses, but who have no tools to tell them whether to grimly hold on for the next bull market, or to sell out on the next rally. Youll be miles ahead of those poor souls whose only guide is the TV talking heads. BASIC TOOLS Lets deal with a few relatively dependable indicators, or tools. Mind you, these fellows shouldnt be allowed to think for you. They could lead you into a trap, particularly if you obtain them via an online service that calculates them for you. The point of any market tool is to add grist for the mill, to supplement that inner judgment we call gut feel or intuitiona pre-verbal wisdom we are all born with, but often has been educated out of us by the time we are adults. Tools should be used as guides. Your thinking should generally conform to them, but only within their broad guidelines. And, as you gain experience with your tools, you will learn when to listen to them and when to ignore some of them. The stock market is probably the toughest field in the world because the keenest minds are in it, in competition with you. Thus, how you use your tools or weapons may well determine how you fare. Note: a number of the indicators listed here can be obtained on a daily basis from various online services, thus saving you, the investor, the job of having to calculate them yourself: 1. Advance-decline line. By subtracting the daily number of advances from declines (or declines from advances) and subtracting (or adding) that difference from a running cumulative total (from an arbitrary starting figure), you measure what the great mass of the market is doing. This is surely the most basic and important tool of them all. What it reflects is usually more significant than what the market averages are saying. Observe the way in which it diverges from the averages for the best clues. Also: note that it meets resistance (or support), usually, in the same way individual stocks do, at places in the past where it stalled. 2. New highs-new lows. Total the last 5 days of the daily new highs; divide by five. Thats the 5-day moving average. Do the same for the lows. Chart the highs in black, the lows in red. Observe whether the highs remain on top during a reaction that has interrupted a major upswing. (If not, its usually fatal to the upswing.) And vice versa. Note whether each successive peak of highs or lows is higher than the previous one as a guide to the soundness of the primary trend. Also, compare highs with highs, lows with lows. You may wonder why I recommend a 5-day moving average here and a 10-day in other places. While these findings are not foolproof, nonetheless the best conclusions, thus far reached, show that in the case of the hi-low index, for example, fewer than 5 days make a moving average too erratic. Such an average bounces all over the chart, making it hard to find any pattern or trend line. Conversely, more than five days smooths it out so much that it can hardly be seen to move, and you cant get much of a message from it. Thus, it seemed 5 days was best for most purposes. But, there are no laws in this field. You can create and mold and alter to suit yourself. Also, the size of your moving average may depend on whether you are a daily trader, a short-term trader, a medium-term investor, a long-term holder, or some of each. The longer term you are, the broader time period you will usually want to measure. 3. Odd-lot balance index (odd lotters buy less than 100 shares). Divide the daily odd-lot purchases total into the daily odd-lot sales. Totals above 100% show the small investor selling more shares than he buys. Below 100%, readings reflect on-balance buying on the part of this so-called bad-timing investor. The only readings of significance are the changes of percent, not the switch from sell to buy or buy to sell. A move from 70 to 90% is as important as from 95% to 115%. Pros often sell when the small investor suddenly buys, or buy when the odd lotter suddenly sells. But the odd-lot is only significant when held up as a mirror to the market trend. And you should act only when the odd lotters depart from their norm. They usually buy in the early stages of declines and sell in rising markets. 4. Odd-lot trading ratio. Add daily odd-lot sales and purchases together. Divide that figure by total market volume for the day. Then, cut your answer in half, because market volume represents a sale and a purchase together as one unit, while odd-lot figures take them separately. The result is a figure between 7 and 13%. 10% is normal. Below that is bullish. Above 10% is bearish. 5. Odd-lot short sales index. When the odd lotters are shorting on a big scale, its about time the market turned up. When they are shorting very little, a decline is not necessarily imminent, but the ground is fertile for it. This index should be kept daily, and as a 10-day moving average, where it is most accurate. The number of odd-lot short sales is available each day in the press. A falling line accompanies rallies; a rising line accompanies declines. Thus, you can ride the trend as long as it lasts, then get off quickly. A very alert student of this index should also watch for special arbitrage transactions that could affect this ratio. 6. Volume. There are probably 25 different ways to measure volume, and there is probably nothing more important to measure and understand. JOSEPH GRANVILLE ON VOLUME In his book, A Strategy of Daily Stock Market Timing for Maximum Profit, he says: The first series of declines in a bear market may be accomplished on light volume and this must be bearishly interpreted simply because the quality of leadership will be excellent on the downside. Volume will be light on the early stage of the decline because the public believes that the decline is nothing more than one of the usual previous dips in a bull market and the result they expect will be another buying opportunity. The early selling is therefore done by the professionals. When the decline does not stop, the public becomes concerned and starts to sell stocks and the volume gradually rises on the accelerating decline. As the decline becomes more rapid, the public gets more and more frightened and now stocks are being dumped. This sends the volume still higher and a selling climax results. Recognizing this climax as a sign for a technical rebound, the professionals now start buying and the market goes into a technical rebound. If the fundamental business background is showing some signs of weakening at this juncture, then such a rebound in the market would probably be considered as a selling opportunity, further declines are yet to come. This pattern can be summarized as: First phase of decline on light volumeprofessionals are selling, and public remains confident. Second phase of decline on heavier volumeprofessionals are selling, and public disbelief over the decline causes them to lighten up. Third phase of decline on still heavier volume leading to a selling climaxprofessionals finish their selling, and public confidence, now shaken, brings in a deluge of stocks. Fourth phase of declinetemporary technical rebound on professional short covering and general professional buying while public continues to sell. The point here is to stress the fact that the most serious declines in stock market history usually started with what looked like a series of meaningless light volume declines; at least the public thought they were meaningless. The quality of leadership was the key. You may create a method of measuring volume that is better than those in frequent use. Personally, I feel improved volume-measuring indexes are badly needed. Volume, in my opinion, is both the most important, least understood, and worst-measured factor in the stock market. Charting pure daily market volume is essential. One can also chart volume hourly, weekly, or monthly, and a 10-day moving average is important too. Then, you can chart the volume of the DJIA or S&P only or any of the other averages or combination of any of them. The variables are almost endless and each has its own special set of interpretive rules, most of which you can learn from simply watching volume figures. Some advisory services regularly comment on these as well as other sources, so one is always exposed to various interpretations. Price tends to follow volume, as a loose rule of thumb. DOW ON VOLUME In May 1901, Charles Dow wrote: Great activity means great movement whenever the normal balance between buyers and sellers is violently disturbed. In January of that year, he wrote: Dullness usually runs to advance in a bull market and into decline in a bear market. |
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