The Agile Trader by Adam Oliensis  
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TA COURSE - Introduction

When I sat down to write these explanations of Technical Analysis it occurred to me that we should be able to answer a few essential questions if not at the beginning of this endeavor then by the time it is finished.

These are the questions that first popped to mind:
1. What is Technical Analysis and how do you do it?
2. What is it good for?
3. What CAN you do with it and what CAN'T you do with it?

If we can be clear on the answers to these questions then we can avoid a lot of confusion and wasted effort down the road. We can approach this discipline realistically and within an appropriate context. After we understand the context of the discipline, and its use, then we can begin to learn it, practice it, and profit from it.

In this introduction we can clarify the questions themselves as well as begin down the path to answering them.


Before we go any farther, and address our three questions, I want to digress and discuss how we're going to approach the subject of Technical Analysis (TA) in this course.

TA can be overwhelming. How do you know what to look for? How do you organize your thinking in a market of 9,000 stocks (and more) trading billions of shares per day? How do you learn your way around?

I want to go after this in the same way you might teach someone his or her way around a city. Just having a map is great, but it's not really a substitute for walking the streets of Paris or New York.

When I was 19 I visited my sister who had just moved to Manhattan. The most fun I had was putting on my running shoes and going jogging. First through the East Village, then uptown through Chelsea and into midtown Manhattan. I jogged up 6th avenue at lunch hour among the hustling crowds and traffic and skyscrapers, and into Central Park. I ran by the lake, and the ball fields, and then suddenly found myself standing between Tavern on the Green and the Sheep Meadows. I walked into the field and sat down there for a while and watched; 5th Avenue to the east, Midtown to the south, the sun now angling down toward evening in the west, and felt what it would be like to think of the city as some place I knew and not as a stranger. You can't get that from just a map.

That's how I'd like for you to learn about TA in this course. In addition to sharing theories and practices of TA (the map of the city) with you, I'd also like to share my experience using TA. (I've eaten at all the Chinese restaurants in the neighborhood, so I know which ones are good and which ones not so good.) I want you to learn the neighborhoods in a way that will save you wasting your time (eating at the crummy restaurants), and help you to develop not just a general understanding, but a useful understanding of what tends to work and what doesn't.


1.WHAT IS TECHNICAL ANALYSIS AND HOW DO YOU DO IT?

TECHNICAL ANALYSIS (TA) involves tracking price, volume, and time data from trading instruments, usually on charts (or on spreadsheets), in order to understand the behavior of those instruments. The goal of understanding the behavior is usually to find advantageous points at which to buy and sell the instruments in order to make money. (But not JUST to make money, also to limit risk.). TA is used in trading commodities, stocks, stock indices, futures, currencies, bonds, and virtually anything else for which data can be collected and organized. Indeed the Japanese began using a kind of TA at least as far back as the mid-1800s in trading rice.

Chartists look for identifiable patterns in the collected data and make our best efforts to predict near-term future behavior based on those patterns. Markets have certain kinds of regular "customs" or "laws." We try to identify them and use them to forecast the future.

In this course we will deal primarily with stocks and stock indices. However the principles of charting apply to all markets, though there are some variations in what works best, or "least best," depending on the properties of the markets under scrutiny. (For instance, the long-term shape of certain commodities markets is essentially flat while the long-term shape of the stock market shows up as an exponential curve. That difference is a function of, on the one hand (commodities), a secular balance between supply and demand and, on the other hand (stocks), of the underlying long-term growth in Gross Domestic Product (GDP) and hence corporate earnings.)

But what are we really doing? What are we measuring? We are measuring buying and selling. We are keeping track of how much buying and how much selling takes place over particular periods of time, and how much that buying and selling moves the price of instruments in question.

Who's doing this buying and selling? There are traders on the floor, there are super computers spitting out program trades, and there are guys sitting in their basements bathed in the effervescence of their computer screens. Millions and millions of decisions are being made all day (and night) long in every corner of the globe. And when you aggregate the whole mess you see a sort of society has coalesced in a marketplace. That market is arguing vociferously, constantly voting with its dollars on the subject at hand (fair value), and struggling mightily to achieve a dynamic consensus. So what we're really doing is measuring complex aggregations of arguments, of human social behavior. Technical Analysis is, in an academic sense, a very specific kind of statistical sociology.

More concretely and practically, though, we want to figure out what the markets will do so that we can trade them profitably.

Ultimately, we have only three elements or substrates to analyze: price, volume, and time. That's all we have to go on. And what we do is try to find meaningful and effective ways of slicing and dicing the data: Price, volume, and time. We might slice the data one way to try to discover momentum. We might slice it another way to try to discern support levels. Another way to find where money is rotating to or from...and another way to define sentiment. But price, volume, and time are all the raw data we have to work with. Everything else follows from there.


2. WHAT IS TA GOOD FOR?

First and foremost TA is good for controlling risk.

The most important thing a TA discipline does is to provide you with a discipline for getting out when you're on the wrong side of a trade. The easiest thing in the world to do is to get on the wrong side of a trade and to get stubborn. That is also potentially the worst thing you can do. Believe me. I have made this mistake. You think that if you ride it out you'll be OK. And the most seductive thing is that often times you WILL be OK. However, there will also be those occasions when you WON'T be OK. The stock will move against you in ways and to an extent that you previously had found virtually unimaginable.

Now, the next part I'm going to write in caps. And I want you to read it all three times. Don't skip over the second and third iterations.

IT IS MORE IMPORTANT TO CONTROL RISK THAN TO MAXIMIZE PROFITS! IT IS MORE IMPORTANT TO CONTROL RISK THAN TO MAXIMIZE PROFITS! IT IS MORE IMPORTANT TO CONTROL RISK THAN TO MAXIMIZE PROFITS!

OK, Oliensis says this is so, but WHY is it so?

In the broadest sense because of the asymmetry between zero and infinity.

What does that mean? Unless you are someone very special you have finite capital. Most likely you have VERY finite capital. With a market of thousands of stocks you have a functional infinity of opportunities.

If you lose an opportunity, you will have thousands more tomorrow. IF YOU LOSE YOUR CAPITAL, YOU HAVE ALSO LOST ALL YOUR OPPORTUNITIES. Your capital is worth more than your opportunities because you must have capital in order to be in a position to take advantage of your opportunities.

Your capital IS your opportunities.

That is why: IT IS MORE IMPORTANT TO CONTROL RISK THAN TO MAXIMIZE PROFITS!

I spend time on this here because I want you to be aware that the most important thing TA can do, if practiced with discipline, is give you specific parameters for managing risk, which is to say, for exiting trades that go bad. And we ALL have trades that go bad. Everyone. Even the most brilliant traders have trades that go bad.

Wall Street history is littered with the corpses of geniuses who trounced the market...overstayed their welcome, and were subsequently wiped out. (Do the names Long Term Capital Management (LTCM), and Stanley Druckenmiller ring any bells?) LTCM (populated by two Nobel laureates among a number of very smart people) went bankrupt betting that what almost always happens would happen "this time." Why did they go bankrupt? Was it because what usually happened DIDN'T happen that time? Well, it didn't happen...not right away... but that's not why they went bankrupt. Their liquidity ran out. The market remained irrational longer than they could remain liquid. They went belly up because they didn't know when to quit, because they didn't manage their risk.

And Druckenmiller (a much vaunted Wall Street savant) was fired as manager of George Soros' fund group when the Tech Bubble burst...again, not just because he was on the wrong side of the market when the bubble burst but because he didn't manage risk when he was on the wrong side of the market.

You can be right a thousand times, become very wealthy, and then get wiped out completely if you manage your risk poorly just once.

Now that we have hammered home the "controlling risk" theme until you're sick unto death of it we can talk about what else TA is good for.

ULTIMATELY IT BOILS DOWN SIGNALING WHEN TO BUY AND WHEN TO SELL. There are a plentitude of ways to measure when it's time to buy and when it's time to sell. There are breakouts, breakdowns, measured moves, bounces and failures (of trendlines, moving averages, etc.), one-day candlestick patterns, three-day candlestick patterns, Fibonacci retracements, Fibonacci price targets, Parabolic Stop and Reverse signals, sentiment measurements, oscillator signals, and a further infinitude bounded only by the limits of human imagination. TA is good for giving you buy and sell signals. Are they always correct? Absolutely not. Can you derive a trading system that is right more often than wrong? You bet. Can you derive a trading system that nets larger average gains than losses? Absolutely. Can you find a method that TENDS to make money? That's your goal.


3. WHAT CAN YOU DO WITH TA AND WHAT CAN'T YOU DO WITH TA?

Will TA give you The Holy Grail? Well, the answer to that is, like most complicated realities, yes and no. TA will NOT give you a mode of trading that works all the time. It CAN, though, if practiced assiduously, and in concert with disciplined risk management, give you an edge, or a set of edges, that can help you trade extremely profitably.

So, if you're looking to be right all the time, if that's your holy grail, then you'll have to look elsewhere. If you're looking to develop a discipline that will, over time, prove out to help you trade very profitably, then perhaps you have come to the right place.

WHAT'S NEXT? Now that we have at least a thumbnail understanding of what we can expect from what follows, we can get down to the basics of how we actually do TA.