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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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I believe that every investor should keep a chart on each stock he ownsChart Reading and Interpretation Pride of opinion caused the downfall of more men on Wall Street than all the other opinions put together. Charles H. Dow DOW THEORY Is Dow Theory old-fashioned? Sure, just like a communications satellite. It still works, almost as well as ever, in bear market or bull. Those who dismiss Dow Theory expect it to behave like any other technical tool. But that was not what Charles Dow had in mind when he created the Averages. His first experiment to create an average that would offer a broad perspective of American business and the economy was made up of 11 stocks, mainly railroad companies. But, during the next couple of years, it became clear to him that railroads did not present a complete picture of the US economy. The new industrial companies, which in the late 19th century were considered as speculative as the Internet companies were in the late 20th century, were nonetheless, in Dows estimation, a major contributor to Americas growth. And the products made by the new industrial companies were being delivered by the railroads, so in 1896 the Dow Jones Industrial Averages and the Dow Jones Railroad Averages were created. Today, the transportation index acts in the same way that the old railroad index did. Dow Theory was seen as a bellwether indicator of economic direction, rather than a stock market predictor. But, over the 100 plus years it has been in existence, it has forecast most major bull and bear markets. The transportation average still needs to confirm the Industrials. Its the oldest theory on Wall Street and one of the few that have stood the test of time. Dow Theory holds that whenever the DJIA moves to a new rally high (or low), the Dow Jones transportation average must do the same (thus confirming the move) shortly thereafter, or else the move is false and cannot long be sustained and a reversal will follow. And vice versa, if the transportation average makes the first move. When the averages hold above the preceding low points, it is construed bullishly; when they fail to climb above preceding highs, it is said to be a bearish signal. Further, the theory holds that the market is forecasting business and that the market surges in three movements. And it has much to say about how volume must act, during the penetrations referred to above. For more details on Dow Theory, I would recommend you read Technical Analysis of Stock Trends, by Edwards and Magee (listed in the Resources section of this book). But to become expert on Dow Theory is virtually a lifetime study, and few have done just that. The man, in my view, who is most capable of Dow interpretation today is my friend Richard Russell. CRITICISMS Critics of Dow Theory during the 1990s said that the transportation index is no longer relevant or, at best, is so insignificant it is not required to confirm the action of the dynamic average. There were even suggestions that a new Dow Theory should be created, to compare the old economy with the so-called new economy. As a rebuff, I would point out that, although many Nasdaq stocks collapsed in 2000, it was only when the airlines (transportation companies) began to falter in the aftermath of the September 11, 2001 attack that even the talking heads on television began seriously to talk about recession. In spite of the criticism, Dow Theory was alive and well and pointed to a bear market long before September 11, 2001. A LAGGING SIGNAL Because Charles Dow designed this theory as a forecaster of business, not a predictor of stock action, confirmation of signals tends to be coincident or trailing, not leading. However, two points should be raised on that score: 1.Even if late, it is important to have a confirmation that still occurs soonenough, in most cases, to let you capture a gain or avoid the greatestpart of a loss.2.If you take partial action based on the first part of an unconfirmed Dow Signal, which is often recommended if the first signal occurs on good volume and other technical indicators are in gear, then you get in on an even larger share of the move. Dow also was adamant that bull markets are born when bear markets take values (dividends) up and price-earnings (P/E) ratios down. Up and down are relative words, so its a general, not a precise tool. But its part of Dow Theory. The greatest use for Dow Theory is that confirmation of the two averages tells you the new bull or bear market is a real reflection of the health of the economy, not merely an internal market correction. But, like any market tool, it is not infallible. Its signals on occasion have been too early or too late to be an absolute truth. Experience is important in its interpretation. So, it should be used in conjunction with all the other tools and indicators we discuss in this book. AVERAGES HAVE CHANGED SHAPE BUT NOT SUBSTANCE The second Dow Jones average has changed shape considerably since it became the transportation index instead of just the rail average. But its raison de?tre within Dow Theory remains valid, in that the production of goods and services will not make an economy hum, unless there are efficient ways to get those products to market. In Dows day, the only way to move goods and people was via the railroads. Today, though we use trucking and airplanes, the principle is the same. STOCK CHARTS In a world and stock market full of uncertainties, stock charts offer no guarantee. But, given their limitations, they provide the nearest approach to a stock market road map. In the realm of stock geography, they help you know where you are, where you have been, and where you might go. Charts are factual records of what has occurred, but the chart reader makes them come alive, and thus the result depends on his ability, judgment, and instincts alone. Each chart is a picture that speaks a thousand words. Theres nothing wrong with charts. Its the chart readers who can fail. That bromide is nearly true. Charts can give false signals. They are not failsafe. There are traps and false moves that even the most perceptive of chartists can miss. But, in dealing with percentages, its reasonable to say that a really good chartist makes far more correct forecasts of forthcoming stock action than incorrect ones. Then, if the chartist follows a principle of cutting losses quickly on the bad guesses, overall he will make a good profit. Before becoming a chart follower, I was happy in my ignorance. But, after my conversion to charting, I could never feel safe in the market again without charts. It would be like starting off on a long trip and finding your map stolen. Charts tell you where to place your orders to buy or sell, based on points where a lot of support or resistance is present owing to past activity at certain levels, or where a stock has formed a pattern from which it has broken up or down. It is perhaps hard for a generation whose only experience of the stock market was that buy and hold was the ultimate in market know-how. But, in todays markets, you need charting methods that have stood the test of decades, and helped chart pioneers navigate through all bear markets of the 20th century. KEEP YOUR OWN CHARTS I believe that every investor should keep a chart on each stock he owns or watches. If you devote 1 or 2 hours a day to your indicators and charts, that is enough. If you own more stocks than you have time to either manually chart, or personally analyze from a computer stock chart service, you are too diversified. As stated earlier, if you have never kept charts, at least for the first few months, I suggest you manually keep your own charts, in order to gain a feel for the patterns as they form. When that sense becomes second nature, its safe to switch to a ready-made chart service. For the average investor (maybe we should say above average because hardly anybody in the stock market will ever admit to being only average), we say a dozen or so stock charts will do nicely, plus a dozen market indicators, on a daily and weekly basis. Add monthly if possible. The rules on how to read a chart properly can be learned only one way. You must read Edwards and Magees book, Technical Analysis of Stock Trends. It is not an easy read, but the knowledge you gain is worth the effort. You will be encouraged to find that stocks are forming the same patterns today that they did 30 years ago and 60 years ago, and even 90 years ago. In bear markets, there are more of certain patterns, than in bull markets, and vice versa. This has always been so. The rationale is that chart patterns are formed by peoples emotional buying and selling patterns. People patterns are what you really see on a chart, not stock patterns. THE BEAUTY OF CHARTS The trick in the stock market has never been what stock to buy or sell or sell short, but when. Thats where charts come to the rescue. Charts will guide you in both what to buy and when. Once you have used a chart to buy a stock, it usually gives you a sell target. Then, you watch for possible negative chart patterns to appear that may alter your targeted sell price. During the 1990s, bull market investing was so easy that some, who felt they had made a decent profit and sold, spent the late 1990s complaining that they had missed extra profits they might have made if they had not sold so soon. But, they were grateful in 2000 when the Nasdaq crashed. The investment climate for the next few years is going to be totally different. Taking small profits will probably be the name of the game. In any case, whatever the climate, charts both protect you and paint the path to profits. The beauty of charts is their capability (based on your interpretative ability) to tell both when to buy and when to sell precisely(!), with logical rationale. Listen to your charts. If they say buy or sell, dont argue. Charts follow the money. So, follow the charts. POINT-AND-FIGURE CHARTS What I have said thus far has been primarily about line-and-bar charts, the type that run a vertical line between the high and low price of a stock, with a short crossbar where the stock closed, and show the volume below the price. But most of my commentary applies equally to point-and-figure charting, which is a different method for achieving similar ends. Point and figure differs from line and bar in concept in that it plots movement of points onlywithout regard to time. The line-and-bar method takes time as well as volume fully into account. Point and figure is done on equal-size squared paper (arithmetical graph paper) rather than the semi-logarithmical chart paper that about half the line-and-bar chartists use. And, instead of a line and bar, it records an X or an O in a connected sequence, following price only, not volume. Entries are made vertically and only when the stock moves a full point (or more, depending on the scale). Reversal of price action starts a new column. Point and figure is less work and takes much less time. But its harder to get the hang of, and much more difficult to get a mental picture fromfor beginners at leastand is not so good for short-term trades. Some say you need to subscribe to a service to get proper figures to post. LINE-AND-BAR CHARTS Some who make line-and-bar charts use semi-logarithmical chart paper. It has been highly touted as necessary to see a move in proper percentage perspective. This is true. But the average investor tends to think in terms of points rather than percentages. If the Dow falls 200 points in a single day, people tend to focus more on the number of points, than on the percentage fall they represent. Semi-logarithmical charts have their uses, and their distortions. If you have time keep both kinds of chart, particularly for the DJIA or S&P. CANDLESTICK CHARTS The third choicecandlestick chartshave become very popular in the West in the last 10 years. They were developed by the Japanese over a century ago to trade rice futures. The name candlestick is derived from their appearance on a chart, which resembles a candlestick with a wick (shadow) sticking out of one, or both ends. The basis for candlestick charting is the relationship between the open, high, low, and closing prices for each trading day. A candlestick supplies two important pieces of information. The thick part of the candlestick, called the body or real body, represents the range between the days opening and closing price. And the color of the real body indicates direction in relation to the days opening price. If the body is filled black, it means the close was lower than the open (bearish). If the body is empty (i.e., white), it means the close was higher than the open (bullish). The longer or shorter the real body, the more bearish or bullish the signal given. As bearish bars are filled in black and bullish bars are left empty as white, it is easy to determine the dominating forces in candlestick charts. The thin lines, called shadows, protruding above and below the real body indicate the extreme high and low for the day. Candlestick chart patterns can be interpreted in the same way as normal bar charts. However, many candlestick formations involving groups of candlesticks are unique to their discipline and must be interpreted via the rules associated with this oriental art. BENEFITS DEPEND ON YOU The benefits of looking at a charted index or charts of stocks and market averages are different for each person for the reason cited by Georg Christoph Lichenberg long ago when he said, A book [or chart] is a mirror; if a donkey peers into you, you cant expect an apostle to look out. |
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