Far from Random E-Book

Richard Lehman

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Bloomberg Professional
• Sprache: Englisch

Seitenzahl: 382

Veröffentlichungsjahr: 2010

Beschreibung

Since Burton Malkiel's seminal work A Random Walk Down Wall Street waspublished, the financial world has swallowed whole the idea thatmarket movement is chaotic and random. In Far from Random, Richard Lehman uses behavior-basedtrend analysis to debunk Malkiel's random walk theory. Lehmandemonstrates that the market has discernible trends that areforeseeable. By learning to spot these trends, investors andtraders can predict market movement to boost returns in anythingfrom equities to 401(k) accounts. Richard Lehman has been a financial professional for more thanthirty years. He studied the first iterations of behavioral financeback in the 1970s as a financial marketer and has since worked invarious facets of the financial industry. His early introduction tobehavioral finance and the more recent introduction to trendanalysis led him to this important discovery.

Leseprobe

Table of Contents

Praise

Also by RICHARD LEHMAN

Title Page

Copyright Page

Dedication

Foreword

Acknowledgements

Preface

WHY SHARE?

Introduction

THE WAVES OF R. N. ELLIOTT

NEW INSIGHTS

THE TREND CHANNEL EPIPHANIES

THE BEHAVIORAL PERSPECTIVE

WHAT TO EXPECT

PART I - A Market of What?

Chapter 1 - The Time Has Come

MISINFORMATION AT THE SPEED OF LIGHT

THE “OTHER” ANALYSIS

TREND CHANNELS

HIDDEN IN PLAIN SIGHT

WHAT THE MARKET IS TELLING US

Chapter 2 - Fundamentally Flawed

TRADITIONALISM

WHY IS WALL STREET FIXATED ON FUNDAMENTALS?

WHAT’S ABSENT FROM FUNDAMENTAL ANALYSIS?

Chapter 3 - Subjective Value

A MORE SUBJECTIVE APPROACH TO VALUATION

A LIFE-CYCLE VIEW OF SUBJECTIVE VALUE

QUANTIFYING SUBJECTIVE VALUE

Chapter 4 - Random and Efficient Markets

EFFICIENT MARKET HYPOTHESIS

THE INFAMOUS RANDOM WALK

WHERE DOES A RANDOM WALK TAKE YOU?

SUFFICIENTLY EFFICIENT

CRACKS IN THE RANDOM WALKWAY

CAN STOCKS BE RANDOM BUT MARKETS NOT?

Chapter 5 - Market Timing

FORGIVE ME FOR I HAVE TIMED

WALL STREET CAN’T TIME

THE RISKS AND REWARDS OF TIMING DECISIONS

ASSET ALLOCATION AS TIMING

DOW THEORY AS TIMING

TREND FOLLOWING AS TIMING

TIME CYCLES AND ELLIOTT WAVES

TIMING AS INVESTMENT STRATEGY

PART II - Behavior, Behavior, Behavior

Chapter 6 - New Thinking in Finance Isn’t Financial

THE MARKETERS WERE FIRST

ROBERT PRECHTER, JR., BEHAVIOR PIONEER

INNER IRRATIONALITY

THE LEFT BRAIN ON WALL STREET

THE FINANCIAL VIEW OF IRRATIONALITY

Chapter 7 - The Behavioral Phenomenon

HEURISTICS

CONCLUSIONS

Chapter 8 - Anomalies

ARBITRAGE

OTHER ANOMALIES

CONCLUSIONS

PART III - Charting a Golden Path

Chapter 9 - A New Market Paradigm

A TALE OF TWO VALUES

PSEUDO-RANDOM

GETTING TECHNICAL

WAGGING THE DOG

COMING TO GRIPS WITH MONEY MANAGEMENT

Chapter 10 - Introduction to Trend Channel Analysis

TRENDS AND CHANNELS

HOW THEY WORK

BECOMING A CHANNELIST

Chapter 11 - Reading Between the Lines

THE GUIDELINES

CHANNEL BREAKS

REDEFINING THE CONCEPT OF SUPPORT AND RESISTANCE

ADVANTAGES OF TCA

Chapter 12 - Putting It All Together

RESOLVING THE BULL AND BEAR CONUNDRUM

USING TCA

Index

About Bloomberg

About the Author

Praise forFar From RandomUsing Investor Behavior and Trend Analysis to Forecast Market MovementBY RICHARD LEHMAN

“An overdue book. Lehman’s persistent wisdom puts investors on the right path to understanding how markets do and do not behave.”

—ROBERT R. PRECHTER, JR. Author of Socionomics and Conquer the Crash

“By dissecting human behavior, investor psychology, and historic market action, Richard Lehman unequivocally proves that the market moves in well-defined, often predictable patterns. In Far FromRandom, he demonstrates a new, simple way to really beat the market. As we noted over the years, ‘Random Walkers, eat your hearts out!’”

—YALE AND JEFFREY A. HIRSCH Authors of the Stock Trader’s Almanac

“As someone who has spent a career as a self-described behavioral scientist, I have found Far From Random to be highly congruent with my own experience on what actually drives consumer or, in this case, investor preference and decision making. While I still believe fundamental market analysis may serve as a valuable frame to understand and assess markets and stocks, the reality is, that on its own, it often falls short in forming a comprehensive and accurate strategy for investing.

In my opinion, Lehman’s focus on behavior finance inclusive of technical and trend channel analysis adds a significant dimension to both the theory and practical application of investing. Importantly, the concepts and their applications can be applied with relative ease and used to form the basis for a structured and disciplined approach to discerning market/stock movement.

All in all, it is absolutely clear that human psychology is a primary driver of real behavior, which may be rational or not, which in the investment realm ultimately impacts markets and stock valuations and this book forms a powerful thesis on how to harness this knowledge in a mostly predictive and financially-productive way.

This is an exceptional book for those who are not satisfied with the traditional approach to investing and are seeking ways to enhance their return.”

—STEVEN J. FREIBERG Former co-chairman and CEO of Citigroup’s Global Consumer Group

“Can the equity market still be considered efficient after getting sliced in half twice in the same decade? Is this simply a random occurrence? Far From Random could not be timelier for what is truly a changed financial market environment, in good part dominated by HFT, mega-flows of levered institutional money, etc. The true marriage of technical and fundamental analysis set against the backdrop of far from perfect or efficient human decision-making isn’t a consideration for investors, it’s a necessity. Rick has hit the nail on the head. It’s time investors finally wake up to a new reality.”

—BRIAN PRETTI, CFA, CFP Chief Investment Officer, Mechanics bank

“In Far From Random, we learn we aren’t so removed from our ancestors as we might think. This book demonstrates that markets are neither efficient nor random, and that being stone-cold frozen with fear (a sabertooth tiger eyes us for lunch) is akin to buy-and-hold-no-matter-what (our securities portfolio drags us down to our doom). Richard Lehman boldly states that human emotion, and not green-eyeshade analysis, is what really drives prices. Far from being nonsense, this view makes perfect sense. This book shows how our collective emotional behavior, and the markets it moves, becomes predictable. That’s an edge any investor would want, and Far From Random will give you a tantalizing glimpse at that edge.”

—JIM GLIDDEN Veteran Wall Street bond salesman

Also by RICHARD LEHMAN

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Also by BLOOMBERG PRESS

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New Thinking in Technical Analysisedited by Rick Bensignor

Technical Analysis Toolsby Mark Tinghino

Trading ETFsBy Deron Wagner

Trading Option Greeksby Dan Passarelli

BLOOMBERG MARKET ESSENTIALS: TECHNICAL ANALYSIS

DeMark Indicatorsby Jason Perl

Fibonacci Analysisby Constance Brown

Chart Patternsby Bruce M. Kamich

A complete list of our titles is available at www/bloomberg.com/books.

ATTENTION CORPORATIONS

This book is available for bulk purchase at special discount. Special editions or chapter reprints can also be customized to specifications. For information, please e-mail Bloomberg Press, [email protected], Attention: Director of Special Markets, or phone [phone].

© 2009 by Richard Lehman. All rights reserved. Protected under the Berne Convention. No part of this book may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher except in the case of brief quotations embodied in critical articles and reviews. For information, please write: Permissions Department, Bloomberg Press, 731 Lexington Avenue, New York, NY 10022 or send an e-mail to [email protected].

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This publication contains the author’s opinions and is designed to provide accurate and authoritative information. It is sold with the understanding that the author, publisher, and Bloomberg L.P. are not engaged in rendering legal, accounting, investment-planning, or other professional advice. The reader should seek the services of a qualified professional for such advice; the author, publisher, and Bloomberg L.P. cannot be held responsible for any loss incurred as a result of specific investments or planning decisions made by the reader.

Library of Congress Cataloging-in-Publication Data

Lehman, Richard

Far from random: using investor behavior and trend analysis to forecast market movement / Richard Lehman; foreword by Lawrence G. McMillan.

p. cm.

Includes bibliographical references and index.

Summary: “In Far From Random, Lehman uses behavior-based trend analysis to debunk Malkiel’s random walk theory. He demonstrates that the market has discernible trends that are foreseeable using trend channel analysis, a form of technical analysis. By learning to spot these trends, investors and traders can predict market movement to boost returns in anything from equities to 401(k) accounts”—Provided by publisher.

ISBN 978-1-57660-323-9 (alk. paper)

1. Technical analysis (Investment analysis) 2. Investment analysis. I. Title.

HG4529.L447 2009

332.63’2042—dc22

2009037202

To Roz and Ed Lehman For 60 years of unwavering support for all my endeavors

Foreword

I HAVE ALWAYS believed that technical analysis is by far the most accurate approach for stock market investment. True, my degrees are scientific (math, computer science), so that may have influenced me. But I have conducted many studies of both fundamental and technical approaches in my nearly forty years of investing, and it is the rigorous, technical approach that is the clear winner.

For example, if one buys a stock and it begins to decline, what is one to do? A technician will likely see that the stock is in a down trend (or no longer in an up trend) and will sell the stock, stepping aside until the stock once again is in a rising mode. The fundamental trader, though, supposedly bought the stock because it was cheap, based on some earnings or other fundamental projection. Thus, when it declines in price, he should like it even better, unless something has changed regarding the fundamentals (unlikely). This fundamental approach is in clear conflict with the accepted principle of “cutting one’s losses, and letting one’s profits run.” In fact, as Far From Random points out, such an attitude can lead the fundamentalist to feel that he or she is right and the market is wrong—a disastrous attitude for any trader or investor to have.

Most fundamentalists are, in fact, partly technical. In other words, they don’t just look at “earnings” but are concerned with things such as the trend of earnings or the price/earnings ratio. Once “price” or “trend” is introduced into the analysis, one has become a de facto technician.

Exploring the role of technical analysis, Far From Random provides a logical and well-constructed approach to the market in general and to stocks in particular. First, the myth that a stock is “worth” something based on its fundamentals is debunked. There is no promise by the corporation to pay anything back to the stockholder as there is to the bondholder. In fact, a stock’s worth is much more likely to be the collective opinion of thousands or millions of investors. Those opinions are often subject to emotion—from acmes of greed to nadirs of fear. A stock’s price will vary greatly based on those emotions.

The conclusion is that traditional fundamental analysis fails miserably at determining the “fair value” of a stock if there even is such a thing. As a result, most conventional Wall Street advice is useless. This fact was never clearer than in the market decline of 2008. A virtual parade of fundamental analysts kept assuring the public that “stocks were cheap” even as stocks plummeted. The problem was that the marchers in this parade had no real way of knowing what “cheap” was. Technicians, on the other hand, were either out of the market (in cash) or were short because that’s the way the price trend was pointing.

Far From Random debunks the myth of the efficient market hypothesis (the so-called random walk). Simply stated, that hypothesis is based on the notion that stock prices are governed by rational, knowledgeable (unemotional) people. We know that isn’t true, at least at market extremes. Stocks fluctuate in ways that traditional finance cannot predict or explain. Human emotions—fear and greed—play huge roles in the pricing of stocks, and those emotions are nowhere to be seen in either fundamental analysis or the efficient market hypothesis.

The case for technical analysis is made rationally and eloquently in this book. The preferred method of technical analysis is one called trend channel analysis. Its objective is to identify the trend and to “ride” it as long as it remains in effect. The logic and attractiveness of such a method should be obvious to all: one stays with winning stocks and exits those that are no longer performing well, with price as the arbiter, not earnings.

In fact, it is often said (by technical analysts anyway), that price is the ultimate technical or fundamental indicator. If you are following a method that has you fighting the price trend, then it is uncomfortable, emotionally and physically draining, and costs you money. So don’t do that. Follow the trend instead.

If you read the pages ahead with an open mind, you will surely see the inadequacies of the traditional Wall Street approach and the benefits of the technical approach. At the very minimum, you should gain an insight to a more logical way of investing with far smaller drawdowns than the traditional “buy and hold” approach—an approach that has been fostered in the United States over the years by brokerage firms and mutual funds, often to the detriment of their own customers.

Lawrence G. McMillan is President of McMillan Analysis Corp, a derivatives research and money-management firm, and author of the book Options as a Strategic Investment, among others.

Acknowledgments

I’D LOVE TO have been able to acknowledge the help I received from dozens of people on the completion of this work, but in truth there were only seven. So it is with particular gratitude that I acknowledge the assistance of the following:

Research assistants: Jeremy Chew, BS, UC Berkeley; Laura Graziano, BS, Indiana University, MBA, Santa Clara University; and David Carroll, BA, UC Berkeley

Statistical analysis: James Wang, Economics and Statistics major, UC Berkeley

Special research: Kristen Lehman, BA, University of Texas

Finance advisor: Wayne Price, Finance Instructor, UC Berkeley Extension

Editing: Melissa Honig, BA, UC Irvine, MA, Cal State Northridge, who knows as much about finance as I do about communicative disorders but who proved to be one heck of an editor and a great sport about my obsession with writing this book.

Special thanks to Lawrence McMillan for his Foreword and for the inspiration I have received from his work over many years in both options and technical analysis. Special thanks also to Chip Anderson, President of StockCharts.com, and his staff for the great work they do on their Website.

Preface

WITH FEW EXCEPTIONS, authors of financial nonfiction are predominantly PhDs and professors of finance writing on their research or industry practitioners writing about their success. That would make me one of those few exceptions, but then my somewhat unorthodox background is precisely what renders me one of the few people who could see the stock market in the way it is presented in this book.

Since I am not a full-time professor (I teach at night at the University of California at Berkeley Extension), I am neither part of the doctoral mainstream nor affiliated with Berkeley’s prestigious Haas School of Business. Therein lies one of my relevant advantages for tackling this subject in that I am not compelled to tow the party line on academia’s view of the financial world or what is acceptable to publish. When I was looking for research associates for the book, I spoke with a recent graduate of the Haas School’s Masters in Financial Engineering (MFE) program, a unique new curriculum designed to satiate Wall Street’s growing appetite for superquantitative analysts. He was interested in working with me until he found out the main subjects included behavioral finance and technical analysis. He said they don’t teach either subject in the MFE program and that the thrust of my book would conflict with the financial principles he was taught in school.

MBAs on Wall Street are, of course, a dime a dozen, but their degrees were historically all in finance. My second and perhaps most significant qualification is that my MBA and most of my Wall Street background was in marketing. I studied consumer behavior—something totally absent in traditional finance curricula and completely foreign to the industry’s mindset. When I began a somewhat unorthodox career path with E. F. Hutton & Co. in 1976, I’m sure I was one of very few marketing people on Wall Street at the time. At that time, there was no such thing as a marketing department or any kind of internal marketing organization.

Our biggest challenge at Hutton was to quickly launch new products in order to replace the revenue the firm was losing as clients moved to discount brokers. That ushered in a whirlwind era of new product launches such as cash-management accounts, tax shelters, listed options, managed futures accounts, and fee-based financial planning. To accomplish this, we did what marketing folks are supposed to do: we conducted primary market research to find out what our customers wanted (and, more importantly, what they were willing to pay for it). In the process, we were finding out for the very first time just what went on in the psyche of investors—what they knew, what they perceived, what they wanted from investing, and what they wanted from their brokers. It was quite an eye opener and totally virgin territory for a token marketing MBA in the investment world.

I discovered very early on that fundamental investment research was inadequate for developing a practical investment strategy, so I embraced the concept of technical analysis—a method of security analysis that relies on the assumption that market data can help predict future market trends. I studied price charts extensively throughout my investment career and spent a great deal of time utilizing methodologies such as Elliott wave analysis.

I have also been a licensed investment practitioner and have held management positions with financial institutions of one sort or another for the past 33 years, dealing with hundreds of brokers and thousands of individual clients. I’ve worked with portfolio managers, mutual funds, and option traders. As such, I’ve gained an extensive hands-on knowledge of the way people act with regard to investing, and thus began my journey into what is now being labeled behavioral finance.

WHY SHARE?

This book will likely prompt some people to wonder why I did not use trend channel analysis to amass a huge amount of wealth before revealing it to the public. There are several answers to that. First, the book is not about a trading strategy or market anomaly that is so specific that it can no longer be effectively exploited once it has been shared with a great number of people. It is about a different way of thinking about the markets, and it can conceivably spawn any number of specific investment strategies and trading techniques, thereby allowing many people to benefit by it in different ways at the same time. It’s also not a get-rich-quick scheme. It can enhance returns and help investors and traders move more efficiently through up-and-down cycles, but it’s not a free lunch.

Second, as with all new market methods, the usual amount of skepticism will exist, and the resulting discussion and interpretation could easily go on for years. The landmark study by Brinson, Hood, and Beebower made public in 1971 concluded that the difference in investment performance among institutional investors was due mostly to sector allocation rather than individual stock picking. The study profoundly altered the thinking and behavior of professional investors and formed the basis for what later blossomed into modern portfolio theory. It took more than two decades for the professional investment community to fully embrace this thinking, and it is still unfamiliar to most individual investors. So while Lehman’s trend channel hypothesis is debated in academic circles for several more decades, I’m hoping many of you will make good use of it in the meanwhile.

Third, withholding information such as this would offend my sense of academic advancement. At this point, I am content to share my revelations in the hope that others with additional insights and mathematical skills can further test, verify, refine, and enhance the theory for the betterment of all.

I chose to bring my work public through a book rather than as an academic article so that I can address it far more comprehensively and so that it can reach a much broader audience of investors as well as financial professionals. It is important to note that in its simplest form, the theory can be utilized by almost anyone with any size portfolio. It can be as useful to a long-term investor looking to position mutual funds in a 401(k) as it can be to a sophisticated short-term trader. The technique lends itself well to visually oriented analysis that is easy to understand and which I have been publicly sharing for several years through the StockCharts.com Website, where it is freely available.

Introduction

FROM MARKETING TO MARKET TRENDS: EPIPHANIES ABOUT INVESTOR BEHAVIOR

PRIOR TO 1975, the word marketing was absent from Wall Street’s vocabulary. On May 1st of that year, however, the brokerage world was forced into one of the quickest and most dramatic transformations in its history as the Securities and Exchange Commission (SEC) banned the fixed commission schedule previously imposed by the New York Stock Exchange (NYSE) on all member firms. The floodgates that held back discount brokerages opened almost immediately, and, for the first time, full-service Wall Street firms were forced to compete on price. Every major brokerage firm lost customers to the new discounters and was pressured to lower commissions for many of the customers who remained. The loss in revenue placed heavy pressure on the firms not only to develop alternate revenue sources from other services or products but also to seek (much to their own dismay) marketing help. As luck would have it, I graduated in May 1975 with a fresh marketing MBA and was looking for work in New York.