Chapter One

Out Of The Box

You know, you should write this down."

    It was October 2, 1997, and I was having breakfast with my boss, Hardwick "Wick" Simmons, chairman of Prudential Securities. Our conversation meandered around many topics but it always returned to the stock market. We marveled at how rewarding the previous couple of years had been for all those who were willing to take a risk in equities. The Dow had gone from 3,600 to 8,300 over that time. Wick kept talking about risk and what it meant to the firm's clients. Those who had been willing to go along with the firm's recommendations, and assumed a modicum of risk, had made a lot of money.

    This reminded me that Prudential had taken risks too, on me. I thanked Wick for being willing to stake the firm's reputation on my research. I reminded him of how proud I was when our firm allowed me to publish what appeared to be an outrageous report (forecasting Dow 7,000) back in June 1995. Prudential and its clients had depended on my risk assessment to invest enormous sums of money. They had been rewarded with a doubling in the market.

    This was the point at which Wick told me I should "write this down." At first I didn't quite understand what he was saying. He explained himself bluntly.

    "I think you should write a book."

    I was flabbergasted. "Why in the world would anyone want that?" I asked.

    "Well, all of us are curious about what made you `step out of the box' and write that bullish report. Some of us still don't know what made you do it. I think a lot of people would want to know what you were thinking about. What did you see that nobody else did?"

    I hesitated for a moment. While I had thought about writing a book, I had never let myself say it out loud. "Well," I said, "there really is a story behind this story. It's got something to do with me personally -- the books I like to read and the intellectual discipline I developed during my years in a Catholic seminary. But mostly it's about history and about technical analysis."

    "Then do it," Wick told me.

TIMING

I can honestly say that I have dedicated most of my professional career to proselytizing for technical analysis. For example, this Monday night, just like on every other Monday night for the last three decades, you will be able to find me in classroom 8 at the New York Institute of Finance teaching the basic course in technical analysis. That doesn't surprise anyone who knows me even casually. I have a mission. I will convince the financial community that technical research is a legitimate form of stock market analysis.

    This fire in my belly was ignited in the mid-1960s when I was first introduced to charting, something that we will explore in detail in later chapters. Once I truly understood how to use the charts that are the core of technical analysis, I realized my career in investment research was not doomed because of a lack of education in fundamental analysis and traditional economic theories. (My college degree was in history and political science. In the seminary I had worked toward a Master's in theology.) I began to think that I might be able to make a living on Wall Street after all.

    Don't get me wrong. All forms of research are needed to do a credible job of determining how individual stocks should be valued. But technical analysis provides a critical element -- timing. We technicians are market timers. We try to determine when to get into (buy) and out of (sell) a stock.

    Fundamental analysts research and create important numbers (earnings, revenues, price/earnings multiples, etc.) and then tell you where they think the stock should go based on their findings. They compare a company to its competitors and try to gauge whether its price is a good value. The idea, to oversimplify, is to buy a good stock, at let's say $20 a share, and hold on to it for a while and presumably sell it years later for $60.

    Now, in the process of climbing to $60, that stock may go to $40, then back down to $25, before it eventually rises to $60. But by the time you sell, the proponents of this approach argue, you will have a nice $40 profit.

    Market timers don't have any quarrel with making $40 on a $20 stock. But we try to do better. Our goal, again to oversimplify, is to buy that stock at $20, and then sell it when it is rising, say, at $37.

    Now wait, you might say. You missed the run-up to $40. That's true. But we also missed the drop back down. If fact, we might take our profits and reinvest in the same issue at $27, during its fall to $25. If our technical analysis is correct, we'll ride up again to say $57. Yes, we might not ride the stock all the way up. But the important thing is we don't ride it all the way back down.

    This approach takes a bit more work on our part, and it's not for people who can't pay constant attention to their portfolios. But in our fictional example we end with a $47 gain, instead of $40. That's a 17.5 percent greater return (before factoring in commissions).

As I've said, I don't think there is anything wrong with fundamental analysis. In fact, if I could do my formal education over, I would love to be an economist -- one trained in the fundamentals -- with a technical bias. Unfortunately, many economists and fundamental analysts do not recognize the value of technical analysis.

    Traditionally most people in academia and on Wall Street were never taught technical analysis. The reason is that very few colleges or universities actually offer the subject to their students. This is because most academics believe in the efficient market hypothesis -- that is, they believe that all information that could move a stock price is known to just about everyone simultaneously. They argue that since news about a company's sales, earnings, marketing efforts, or technical snafus is communicated just about instantly to everyone, it is impossible for one person to see a trend earlier than anyone else. To them, it's impossible to anticipate a market turn, and technical analysis is useless.

    Historically, the academy has attacked the notion of anyone being able successfully to time the market with any regularity. But the success of many market timers has caught the attention of more open-minded professors and investors. Our reputation is improving rapidly, and credible research is being done that shows you can successfully use price momentum to time the market.

    As I write, a historic alliance is being formed by the Market Technicians Association, the official organization for technicians, and a very highly respected business school on the East Coast. (I'll give you a hint. It's a member of the Ivy League.) Together they are in the early stages of setting up a center for research into technical analysis. Great news indeed, not only for technicians but for all serious students and investors alike.

    But, in the words of one of the professors at that prestigious school: "There is one problem. The word `technical' has a black eye!" This is true. Too many tenured professors will not accept the word "technical," but they are now willing to research the concept, convinced that the underlying ideas have validity. These newly enlightened professors feel more comfortable with the phrase "behavioral analysis."

    My guess is whatever we end up calling the center it will have "behavioral analysis" in the official name. As far as I am concerned, you can call it what you want. What is important is that more and more people will get to understand the technical factors that govern the market's performance. This is a breakthrough that I would have had trouble imagining back in the early years of my career, when I began to believe what history and data were telling me.

THE MOST DIFFICULT MARKET

The year was 1970, and I was part of a scorned breed, scorned at least on Wall Street. People who did what I did -- recommending stocks based on historical price patterns -- were literally laughed at by many of the Street's citizens. I couldn't accept this. I talked this over with two new friends, John Brooks and John Greeley at the brokerage firm of Francis I. Dupont and Co., who like me were succeeding with technical analysis. We knew it worked and, in an effort to improve the credibility of our methods, we started talking about creating a trade association for technicians. It would be a way for us to meet, share thoughts, and compare ideas, the way other Wall Street professionals did.

    To raise our profile, we enlisted the help of the two top names in our field, Robert "Bob" Farrell at Merrill Lynch, Pierce, Fenner & Smith and my boss, Alan R. Shaw of Harris Upham and Co., which is now part of what is known as Salomon Smith Barney. After much debate over whether or not we would actually get taken seriously enough to create what would be the first national organization of technicians, we decided to give it a try. And then Alan suggested something that was as daunting to me as starting the association itself.

    "You know, of course, you'll have to get the blessing of the Old Man."

    I didn't need to ask whom he meant. The Old Man was Ken Ward of Hayden Stone and Co. At the time, he was one of the oldest living technicians. Mr. Ward was close to seventy years old. He had seen it all, from the Roaring 1920s and the Crash of 1929 to the Great Depression, World War II, and the long bull market of the 1960s.

    Alan was right, of course; we would need Ken Ward's support. So after working up my nerve, I called him on the phone. At first he told me in a clipped, serious voice, that any campaign to improve the image of technicians would fail. He called me "young man," and said we would never be taken seriously. There were too many obstacles. It was too soon. People weren't ready to believe that you could actually determine how the market and individual stocks would behave in the future based on stock charts and analysis of their past performance.

    But of course I was young and wouldn't take no for an answer. Both John Brooks and I kept pushing and finally Ken did agree to participate. But he required two things in trade. First, every member would have to be a technical analyst who followed equities -- corporate stocks not commodities. Second, he or she had to be the author of a technical market letter sent to clients or be the writer of technical reports that were sent to portfolio managers at an investment management firm.

    Ken Ward was determined that our members be working for either an established Wall Street brokerage firm or an investment company where the firm had to be taking them seriously enough to let them make recommendations to clients. In the end, we could find only eighteen people who met those requirements at the time. Together we became the Market Technicians Association (MTA).

    At our first meeting, I finally got to meet Ken Ward in person. This, for me, was the equivalent of meeting my childhood baseball idol, Joe DiMaggio. Ken Ward had lived through most of the bull and bear markets of the century. I wanted to know everything he had learned from this experience.

    I asked him, "Mr. Ward, what was the most difficult market you ever experienced?" And as I asked the question I remember feeling really stupid. I anticipated his response and said, "Of course, it was the Crash of 1929." Then he surprised me with his answer.

    "No, kid. That was a layup. The toughest market I ever saw, by far, was the one from 1962 to 1966. If you go through something like that, it will be the roughest thing you'll ever experience."

    I did a double take.

    "But the market went up during that time" I blurted out. "It was a steep bull market that went on for several years. In fact, between 1962 and 1966 didn't the Dow go up about 75 percent?"

    "That's right, kid," Ken Ward replied. "It went up and up and up, and rolled right over all of us, bulls and bears alike. Nobody believed it. And it made us look like fools."

    As he talked I realized just how remarkable that climb had been. That bull market continued, on and on, despite events that could have crippled it, including: the Cuban Missile Crisis, President Kennedy's assassination, and President Johnson's heart attack.

    "The biggest mistake we all made was that we sold the good-looking stocks too early," Ken Ward continued. "It was a time of vicious rotation [when investors move out of one sector and into another], very vicious rotation, and a time when one really had to believe that we were in a secular bull market to benefit, and very few of us were able to understand that we were, in fact, in a secular bull market."

    Ken Ward was absolutely right. The market he was describing had gone way up and rolled over everyone. From June 1962 through January 1966, a period of three and a half years, the Dow Jones Industrials climbed 75 percent. Impressive indeed.

    But the increase of that market, from 1962 to 1966, was only a tiny fraction of the bull market we've seen recently. Between November 1994 and today, in early 2000, the Dow rose more than 200 percent. Unfortunately for many, many people on Wall Street, and even for many technical analysts, this bull market did the same thing that the bull market of the 1960s did to Ken Ward and his colleagues. It has rolled over all the bears and even the bulls. The market made the careers of those who chose not to fight the trend, but it destroyed the reputations of those on Wall Street who chose to fight it.

    As a technical analyst I watch the market. The entire market. And by tracking individual stocks (the bottom up approach) I can assess the direction of not only groups, but of the market as a whole. Why do I devote this much attention to such details? Because the most important thing to an individual investor is his or her specific portfolio.

    I know from my many years of experience that you also have to take a top-down approach (study overall indicators and indices). Once you have established to your satisfaction that you are either in a bull or bear market, then you can trade accordingly. Deciding where you think the market is going to go is an important first step because you need to think and act differently in a bull market than you do when you expect the market to be bearish.

    Naturally, every type of analyst tries to predict the future. Fundamentalists focus on the earnings of companies within specific sectors. Quantitative analysts (a.k.a. the quants) take the numbers generated by all the fundamentalists and back test them for all sectors and all companies. They try to explain whether a company is overvalued or undervalued relative to itself, to its peers, and to the overall market.

    In contrast, we technicians plot and study a different set of numbers -- price and volume -- and read the resulting charts in light of important historical factors. We watch trends in actual trading: Has a stock been steadily rising or falling in price? And then we look for the exceptions and ask ourselves: Is the trend changing? We search for recurring price patterns, and increases or decreases in volume. We respect market psychology and live by the dictum that buyers (demand) push stock prices up while sellers (supply) force stock prices lower.

    This dictum is absolute. It implies that someone out there knows more about the company in question than we do. And if enough of these "informed investors" decide to buy or sell on information that we do not have, then we must respect their action.

    This bias -- that the marketplace includes wise buyers and sellers -- results in the old adage: "Don't fight the tape." If enough investors want a specific stock, or the market in general, to go higher, it will, regardless of what any one individual thinks is right. In this situation, technicians believe it is better to get on the moving train than to stand in front of it.

    We technicians also look at recurring factors such as presidential cycles, and seasonal events such as year-end rallies. I personally take one more giant step and ask "why?" I accept without questioning that a certain trend is unfolding -- I have no intention of getting in front of a moving train -- but I insist on finding out what is causing prices to move.

    Understanding the cause will help me anticipate how long a trend may last. It's hard to overemphasize how different this approach is from the typical Wall Street bias. The "establishment" on the Street actually does the opposite of what I do. They predict where the market should go based on their estimates of value, earnings per share, and the like, and then complain when the market doesn't respond the way they think it should or does something that they can't explain. Quite often they wind up fighting the tape, or to use another image, they get trampled by a rampaging bull.

(Continues...)

Copyright © 2000 Ralph Acampora. All rights reserved.