Technical Theory

So a couple of months ago I decided to pursue a Financial Technical Analysis certification through the IFTA (International Federation of Technical Analysts) called the “Certified Financial Technician“, or CFTe. This entry will be the first of many as I study the course materials. Please see the posted references for the source material.

We’re told in Chapter 1 of Robert D. Edwards and John Magee’s financial tome, Technical Analysis of Stock Trends, that there are two leading ways to analyze the markets. Technical and Fundamental Analysis. We will concern ourselves with the former. The authors spend a considerable amount of time touting Technical Analysis (The internet and the younger crypto crowd have dubbed technical analysis as ”TA” so it’s TA from here on) over Fundamental Analysis. In fact, they almost attack fundamental analysis to the point that it begins to feel like a sports fan telling you that his team is better than any other. So far I’ve managed to keep myself free of this attitude, which seems to be rampant within the analyst community. (The author notes that a third form of analysis has surfaced in recent years called “Cyclical Analysis”)

Firstly, in order to put your faith in TA, we need to understand that the market has been exhaustively studied. And that throughout those studies it remains that both risk and reward are ever present, abundant. You don’t hear an overwhelming number of traders complaining that after weeks or years in the markets, their statements have been flat, do you? No, they got rich or poor. Hence, the high risk and reward. Well it’s our goal to be on the winning side of that ratio. I’ve no illusions that this daunting task will be anything easy. Disclaimers abound, everywhere you turn, professional traders recite statistics like, “90% of traders loose”. Aside from the obligatory disclaimer, brokers are relatively quiet on this subject, confident no doubt in the fact that fools will rush in and all but hand over their kids college fund…

Fundamentals require statistics such as financial statements, balance sheets, profits, managerial rosters, etc. FA looks at all of this then considers it’s stock as a buy or a sell. It is all “priced” or “discounted” into and out of the market. Fundamentalists (I sort of smirk when I have to call them that) look at all that dry data and decide if it’s a good buy or not. It’s cheap if it costs less than the traders appraisal and expensive if it exceeds it. But Edwards and Magee tell us that this method is better for buying companies than it is for day trading stocks. People who do this sort of thing exclusively seem to be a dying breed but come across one, and we are derrided as “Chartists”. I saw one of these exchanges recently between two commentators on CNBC. In this case the technical analyst did seem to be a bit of a moron since he kept misquoting info, but I bring this up to highlight the open animosity between the two camps, not to score one over the other for team “TA”. Watch this video, (if it remains available), You’ll hear one guy slamming the technical analyst, It’s almost cringe-worthy.

“We got the chartist here, he’s got his stick and it’s fantastic pal”.

(Watch it from the start if you want but I suggest you start at the beginning of the relevant portion. It starts at 2:49. )

Anyway, you see these attitudes are still present decades after Edwards and Magee wrote this book.

Technical Analysis is defined as a study of the graphical representation of market action in an attempt to deduce future trends. Dow theory, of course is the precursor to technical analysis and perhaps, the first genuine instance of it. But we’ll get into Dow further on down the line.

The authors give us examples throughout the book but in this particular case it was US Steel through the 30’s and 40’s. They show how the company’s book value may have swung 20 or 30 dollars per share in one direction or the other, but the stock value was much more volatile. From the fall of ’29 to the summer of ’32 the stock fell over $230. This was due to changes in interest rates and world events and a multitude of other factors. They point out that this rate was much more accurate because the price was considering sentiment and this range of other applicable factors not highlighted in the company’s financial records. And I have to agree that these things, once we study them, become self evident. Not to mention the fact that some corporation may be “cooking the books”, as the fictional Wall Street villain “Gordon Gecko”, once said,

“Look, Jerry, I’m looking for negative control ok, no more than 30 to 35%, just enough to block anybody else’s merger plans and find out from the inside if the books are cooked.”

The real value is reflected in the market price and determined by supply and demand over the exchanges. Contributing factors include sentiment or other rational or irrational reasons. Market price is where the depth of buyers and sellers converge and so all operating costs, earnings, quarterly statements, along with sentiment, exuberance etc. is all included in that fluctuating price. To elaborate, fundamentals might be flawed or incomplete. There maybe some insider data being thrown about amongst market makers or whales, and the market price is what properly settles it. Not the company’s book value.

All in all I tend to agree with the authors. Price action is a decisive element no doubt, but I wont rule out using fundamentals to feed me some data here and there. Especially this early on in my quest for knowledge.

The book’s editor, W.H.C. Bassetti has been adjunct professor at Golden Gate University in San Francisco. In recent years the publisher has included him as a co-author of the book since he has maintained it’s releases for so many years. You can see Bassetti deliver a fantastic lecture on YouTube, which I will embed in full at the bottom of this entry. We will be sticking with this book for some time. I want to make sure I really bite down on trend and reversal patterns because I’ve found a lot of excellent traders touting chart patterns and price action over technical indicators. This book, aside from being required reading for the CFTe, seems to be great for that.

Maybe you want to follow along? You can pick up the most recent, 10th edition of Technical Analysis of Stock Trends on Amazon here:

https://www.amazon.com/dp/1439898189/ref=cm_sw_r_tw_dp_U_x_NdJZAbXBDT8BV

Part 1 of 5: