First of all, some deﬁnitions: technical analysis is based on the actual behaviour of the market, as expressed by price, volume and Size of the short interest (for securities trading) and open interest (for futures). The technician relies on the action of the market, through the use of charts and technical indicators, to help determine when to buy, to sell or to stand aside. Fundamental analysis is based on an analysis of the economic factors underlying the stock or commodity. It seeks to determine the basic causes of price change, and to evaluate whether a stock or a commodity is overpriced, underpriced or fairly priced, as rooted in economic factors such as earnings, dividends, price-earnings and other pertinent ratios, plus various balance sheet items (for securities); and production or crop size, carry over from the previous year, demand in the coming year and competitive supply (for commodities).
The best way to introduce this important subject is with a story — a true one.
My friend, Tony, who was one of the major ﬂoor brokers on the New York Mercantile Exchange, and I were sailing on the waters of Long Island Sound, New York. It was a hot, windless summer
afternoon and we had been drifting along for half an hour, waiting for the anticipated two o'clock southerly wind to pick up and send us scurrying down Long Island Sound for an exhilarating fternoon of sailing. Neither of us was an avid conversationalist and we had exhausted our normal topics, which is probably why we got involved in the conversation I am about to relate. Now, all my friends know my cardinal rule, that I never want to hear anyone's market opinion, not do I care to give my own. But here we were, all of a sudden, talking about the heating oil market. Actually we weren't talking; it was Tony talking and me listening.
'I'll give you some very conﬁdential information,' he said, 'but you must promise not to tell anyone.' 'Look,' I replied, 'I'm not interested in your tip, so please keep it to yourself.' I thought that would discourage him. Wrong. It didn't take him more than a minute to recover from that mild rebuke, and he started again. 'Be serious,' he said. 'I'll let you in on it, but don't tell anyone that I tipped you.' He was really determined, I thought; it must be something really special. And it sure was. 'Sheikh Yamani will shortly announce that the Saudis will double their oil production.' A long pause ensued. 'So what,' wa the best I could respond. But Tony was persistent. 'So what? ls that all you can say? Don't you realize the signiﬁcance of this news? When the oil minister of the world's leading oil producer is bout to announce that he will be doubling production, the market is sure to drop by US$20.00, maybe even US$50.00 over night. There's a fortune to be made here, and I've just dropped it in your lap. Besides, all the big ﬂoor traders have gone heavily short.' l have heard all I cared to hear. Besides, who wanted to have this nonsense ruin what would soon be a great afternoon of sailing? 'Look,' I retotted, 'I don't know very much about the Saudis or their oil minister, or about oil production and its effect on heating oil prices. And I certainly don't know, not do I care, about the "big boys" and what they do, or don't do in the market.' (Actually, I had heard so many 'big boys' stories through the years, that I was totally immune to them.)
'What I do know, though, is that this marker is now heading sideways, but with a bullish bias, and in my opinion, it looks like it wants to break out on the upside and rum into a roaring bull market. So, can we please talk about something else, now?' Well I ﬁnally prevaied, although I had never seen this unﬂappable professional trader look so stunned. But my gambit rescued the day, and the
balance of the aftemoon turned out just ﬁne.
The aftemoon's conversation wa very much on my mind that evening and, upon retuming home, I wasted no time setting out my charts and technical studies for a careful re-examination of the heating
oil market. Perhaps there was something in this scenario that I had overlooked or misinterpreted, and a mreful double-check seemed like a good idea under the circumstances. It was mid-July 1985. and the heating oil market had been locked within a tight trading range, between 70.00 and 73.00, basis the February 1986 future. Although the majority of traders were heavily short. some of the objective computer systems had already signalled to cover shorts and go long on 10 july, and I was just waiting for a close of over 74.000 — and the strong market action 'told me' that this breakout was likely to be imminent — to tum me full bore onto the long side, with the expectation of a major upwards move in the ofﬁng. Let the 'Big boys' and their hapless followers exchange tips and gossip regarding Minister Yamani's anticipated announcement and its possible effect on the market. As far as I was concerned, I was anticipating a bull market, period! Yamani either would, or would not, make the announcement; and even if he did, the bearish news was probably already been discounted in the market price. And the announcement, if there was to be one, would in my opinion, be the ﬁnal ray of hope for the trapped bears prior to their being massacred by the strong and rampaging bulls. In short, my technical studies 'told me' that we were, once again, about to see the classic 'bear trap' in action. Discretion being the better part of
valour, I opted to sit out this bear tip from the safety and serenity of my long position in Febmary heating oil.
This was fortunate for me because, following a few more weeks of sideways price action, during which time the 'big boys' and their followers had ample time to get further committed on the short side, the market on Friday 26 July closed strong, just below 74.00 for February. That did it! The trap had been sprung on the unfortunate bears, and following one last gasp brief price reaction, the market commenced an impressive rally that ultimately carried some 16.00 cents, equal to US$6,70O per contract (see Figure 4.1). "
What was even more amazing was the fact that Sheikh Yamani did, in fact, announce that he would be doubling oil production (Tony was at least right about that part of the tip) and predicted a sharp drop in heating oil market, however, is the ultimate authority, and was not impr with this bearish tip. In its frantic race towards higher levels, it barely stumbled over the oil minister's 'epic' nnouncement. This must have shocked the intrepid and greatly pained shorts who, in the end, lost tens of millions of dollars due to their blind acceptance of a beau' tip in a bull market. There is a very clear-cut lesson to this story: beware of tipsters and other ﬁnancial gossips bearing free market information or well-
intenrioned advice. And when the fundamental and the technical condusions are at odds, you disregard sound, objective technical conclusions, or hang on to anti-trend market positions, at extreme peril. At all times, it is necessary to focus on an objective analysis of market trends and high volume breakouts from existing trends. Successful operators have trained themselves to ignore, and admittedly that's not easy, the hysteria and sounds of alarm that accompany the plethora of supposedly informed market pronouncements and tips. Hong Kong has some of the canniest and most experienced traders anywhere in Asia. The Hang Seng Index futures provide excellent
Figure 4.1 February 1986 Heating Oil. During June and July 1985, the market was locked within a tight trading range between 70.00 and 73.00. Despite major short positions on the part of many ﬂoor traders anticipating a bearish announcement from the Saudi oil minister, the market broke out on the upside on July 26, commencing a major bull move to the 90.00 level. This resulted in losses of many millions of dollars to the big guys and their hapless followers, who had been caught in the classic bear trap that they had so often engineered in the past. Their mistake? Following a bear tip in a bull market.
Hong Kong Index futures provide excellent trading opportunities and action for speculators. Yet, throughout the three years, from 1991 through 1993, during a period of generally rising stock prices from a world class bull market, where prices rose from approximately 3,000 to over 12,000 (see Figure 4.2), traders continuously probed the short side of this stunning bull market. Every time there was some bearish—sounding news in the press, every time some commentator or interviewee delivered a bearish pronouncement, and especially when any British official talked about Sino-British
Figure 4.2 Long—term weekly chart of the HANG SENG INDEX, for the period July 1990 to July 1994. Note the impressive bull market lasting four years, during this period.
disharmony, the market suffered a serious bout of 'bear attack.' In fact, during late 1993, when the Hang Seng was undergoing its most violent and steep upwards move, I watched in amazement as a large ofﬁce full of traders and account executives peered intently at a small TV monitor listening to a speech by Govemor Chris Patten while the market was open. During the course of the speech, every time the Governor mentioned any aspect of Sino-British problems at the negotiating table, a ﬂood of long liquidation and new short selling engulfed the market. Traders were pparently willing to totally overlook the ongoing trend of the market, which was clearly one way; up. In fact, over the course of several months of an upward trending market, I heard dozens of pronouncements from brokers and traders that they were selling the Hang Seng for a number of diverse reasons.
0 The market looked overpriced'
0 The market was due for a big correction
0 They had received a bear tip that prices were about to turn down
0 The principal reason for the rising prices had been massive buying by a big New York investment house which would shortly reverse to short and take the market down again.
In reality, the market was in a clear-cut and distinct uptrend and there was no viable, objective reason to play it short.
A large body of speculators had succumbed to a combination of undisciplined wishful thinking and a desire to be short in the market (they had liquidated long positions prematurely because prices were 'too high,' so they would now prove their acumen by getting aboard the short side). The great quantity of 'red ink' that accompanied these short positions was additional evidence, as if traders needed such additional proof, that trying to pick off tops or bottoms, against a strongly entrenched bull market trend is invariably dangerous to one's ﬁnancial health and well-being.
The absolute need for a disciplined and objective approach to speculation, whether it be in stocks, commoditites or currencies, is a recurring theme of this book. We have all had the experience of relaxing our vigilance, of ignoring the real technical condition and direction of a market, which is generally clear if we are willing to see it. And, the results are uniformly predictable; unsuccessful trading and a string of consistent losses. Unfortunately hope versus fear, impatience, greed and, above all, a lack of discipline, are the major impediments to successful operations.
By way of an example; in the summer of 1984, the Chicago grain markeks vere in the process of breaking down from broad sideways trends into clear-cut downtrends. Most of the reliable long—term trend following computer trading systems had turned down, as had most objective chart techniques. This was conﬁrmed, as though further conﬁrmation was required, when the commodity Research Bureau (CRB) grains futures index broke down through the 230.00 level (see Figure 4.3). Yet, the reality of this developing bear trend, so strongly entrenched that it persisted for two more years, was generally obscured by a steady barrage of bullish stories and articles in the business press about poor US growing weather and its damage to crops, unprecedented Soviet grain shortages which would lead to huge purchases of world grains and reduced Canadian crops. So, one has to ask, why were the grain markets sliding into a tenacious downtrend that was to last nearly two years?
A parallel situation was experienced in the metals markets commencing around mid-1984. Most of the market projections, economic analyses and brokerage advisories had predicted improving prices and had clearly recommended the long side of the metals markets. Long side indeed! And, here again, the CRB precious metals index tells the same story (see Figure 4.4). Prices poised on the brink "of yet another downleg, soon to be conﬁrmed by actual market action, during the relentless bear markets of the early 1980s. Digesting such a steady stream of bullish pronouncements could hardly fail to give one a bullish bias. However, an objective and pragmatic review of the technical factors clearly showed that we were
Figure 4.3 CRB Grain: Future: Index. 1984 was a year of confusion and conundrum for the futures trader. The news and recommendations were most universally bullish, and speculators bought into the ﬁrst quarter rally on the assumption that prices were starting to head north. In reality, this brief advance was just a minor pause in the major bear trend that had gripped futures market since 1983 and would continue through 1985-86. Only the disciplined and pragmatic technical trades made money—and lots of it—
on the short side of these rnarkets. entering a bearish scenario. Successful speculators, with a disciplined and pragmatic approach to trend analysis and utilizing a viable trend-following strategy, would have ignored all that market gossip and have focused instead, on a sound technical analysis. In so doing, they would have either scored some good proﬁts on the short side or, at least, have avoided the long side and its attendant trap
In summary, the frequent divergence between what one observes in an objective technical analysis, and what one reads in the so-called news and analysis, seems to provide a near-permanent feeling of ambivalence to many speculators. 'For example, it is generally difficult for the speculator to operate in the currency markets on the basis of fundamental expectations or market gossip. Following weakness in currencies some time ago, the major New York ﬁnancial papers noted, 'The US dollar surprised traders with a show of strength yesterday that stemmed, in part, from the detention of a Polish labor leader.' The
Figure 4.4 Precious Metals Index
Deutsch Mark was weak, which was attributed to the fact that German banks are major creditors of Poland. However, the Yen happened to be strong that day, so the same artide deftly labelled its strength as a result of Japan's isolation from Europe. However, had the Yen declined, or had the Deutsch Mark advanced, you can be certain that an appropriately — worded rationale would have been created, and disseminated.
When I ﬁnd myself becoming excessively confused or agitated by an excess of such obvious contradictions and contrived after—the-fact announcements and quasi-analysis, my response is to seclude myself from this so-called news. I focus, instead, on a detailed and pragmatic analysis of technical factors and indicators-trying to seek order amongst the chaos. Such an interval is always best conducted in seclusion, away from interruptions and well-intentioned advisors. There seems to be a correlation between the isolation and tranquility of the session and, the clarity and quality of the analysis.