The Master Trader E-Book

Laszlo Birinyi

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Wiley Trading Series
• Sprache: Englisch

Seitenzahl: 351

Veröffentlichungsjahr: 2013

Beschreibung

Alongside Laszlo Birinyi's stories from his more than forty years of trading experience, the book provides guidance on critical trading and investment issues, including: * What the market will likely do if Spyders are up one percent in pre-trading * Whether to buy or sell when a stock reports better that expected earnings and trade up to $5 to $50 * The details behind group rotation and market cycles * The seasonal factors in investing * Indicators, explained: which are indicative and which are descriptive * The importance of sentiment and how to track it The book will include chapters and details on technical analysis, the failure of technical analysis efforts, the business of wall street, trading indicators, anecdotal data, and price gaps. The Website associated with the book will also feature data sourcing and video.

Leseprobe

Contents

Cover

Series

Title Page

Copyright

Dedication

Acknowledgments

Preface

Chapter 1: Technical Analysis: Fuhgeddaboudit

INDICATORS: PICK ONE, ANY ONE

1990: ANOTHER OPPORTUNITY MISSED

NOTES

Chapter 2: The Failure of Technical Efforts

A LACK OF ANALYSIS . . . (AGAIN)

THE ADVANCE/DECLINE LINE: A FAVORITE TOOL, BUT WHY?

VOLUME? ANOTHER IMPORTANT INDICATOR? REALLY?

NEWSLETTERS—ONCE UPON A TIME . . .

PREDICTING RAIN DOESN'T COUNT; BUILDING ARKS DOES

TECHNICAL ANALYSIS FAILS A RIGOROUS TEST

NOTES

Chapter 3: Technicals: The Last Word

TOPICAL STUDIES: AN INTRODUCTION

NOTES

Chapter 4: Wall Street: Games People Play

A BROKERAGE FIRM CAN'T CALCULATE PERFORMANCE?

MR. PRECHTER

NOTES

Chapter 5: Money Flows: The Ultimate Indicator

PLAYING WITH BLOCKS

IT IS NOT HOW OFTEN; IT IS HOW MUCH

THE SEC'S STUDY ON THE INFORMATION FROM LARGE TRADES

WALL STREET WEEK: THE RECORD

APPLE IS A BUY AT $3?

MR. MARKET'S VOICE

NOTES

Chapter 6: Anecdotal Data

MAGAZINES AND NEWSPAPERS ARE DATABASES IN DISGUISE

DOW THEORY IN REAL TIME

MAGAZINE COVERS—OVERRATED

NOTE

Chapter 7: Always Cut the Cards

STRATEGISTS: MORE MARKETING THAN MARKETS

STOCK MARKET RESEARCH: AN OXYMORON

THE ISSUE OF CAPE: CYCLICALLY ADJUSTED PRICE-EARNINGS RATIO

STRATEGISTS: ONE MORE THING  . . .

WHAT DO STOCKS REALLY RETURN?

A SUCCESSFUL MODEL EXCEPT FOR “IRRATIONAL” INVESTORS

THE PRESS SHOULD BE IN THE REPORTING, NOT FORECASTING, BUSINESS

NOTES

Chapter 8: DOW: 19,792?

CITIBANK (THE COMPANY) VERSUS CITI (THE STOCK)

WORLD WAR I: THE MARKET SWOONS, OOPS, RALLIES

THE DOW TRADES ABOVE 1,000

NOTES

Chapter 9: That's Easy for You to Say!

BUSINESSWEEK: 1998, 1999, AND AMERICA ONLINE

BEST: REAL TIME, REAL MONEY, REAL RESULTS

NOTES

Chapter 10: Playing the Game

MR. BUFFETT BUYS AND SELLS SILVER

BONDS CAN GO DOWN

MR. ELLIS: THE LOSER'S GAME

WALL STREET WEEK: WE WERE LUCKY (FOR EIGHT YEARS)

MONEY MANAGERS DON'T GET IT?

NOTES

Chapter 11: Have It Your Way

WEASEL WORDS: NOT OUR CHOICE, BUT KNOW AND RECOGNIZE

Chapter 12: The Market: Yesterday, Today, and Tomorrow?

COMMISSIONS GO DOWN; ERISA CHANGES THE RULES

LONDON'S BIG BANG: A FAILURE THERE, A GOOD IDEA HERE?

THE PUBLIC VERSUS “ALL OTHERS”

HIGH-FREQUENCY TRADERS GET BILLIONS, BROKERS PROSPER, BUT ARE YOU BENEFITING?

THE DEMISE OF THE JAPANESE MARKET WAS STRUCTURAL

NOTES

Chapter 13: Get Ready, Get Set . . .

TRACKING SENTIMENT, OR, KEEPING SCORE OF THE PLAYERS

NOTE

Chapter 14: Market Cycles and Rotation

HOW TO TELL WHETHER WE ARE IN THE EIGHTH OR NINTH INNING

GROUP ROTATION EXISTS; IT IS RANDOM BUT WORTH UNDERSTANDING

SMALL STOCKS: ON AVERAGE, YES, BUT . . .

GROWTH VERSUS VALUE: ADVANTAGE GROWTH, BUT . . .

NOTES

Chapter 15: The Economy and the Federal Reserve Board

GDP AND THE MARKET, NO SURPRISES HERE

THE FED TIGHTENS: IT HURTS ONLY FOR A LITTLE WHILE

1994: A LITTLE PERSPECTIVE, IF YOU PLEASE

1995: ECONOMISTS PREDICT BECAUSE THEY ARE ASKED, BUT WHY?

NOTE

Chapter 16: Picking Stocks

SEEDS: IDEAS TO GET YOU STARTED, PLANTING, AND HARVESTING COME LATER

SPRAINED WRISTS EVENTUALLY HEAL (AND PROSPER)

CAPITULATION: ANOTHER EXAMPLE OF THE ANECDOTAL PROCESS

TREND CHARTS: LATE IN, EARLY OUT, BUT PROFITABLE AND COMFORTABLE

NOTE

Chapter 17: The Trading Day

THE MORNING AFTER A BIG DAY

WHAT DO FUTURES TELL US?

IT'S 10:00 A.M.: DO YOU KNOW WHERE YOUR STOCKS ARE GOING?

Chapter 18: “Mind the Gap”

AFTER THE POST-MARKET FALL . . . OR RALLY

GAPS PROVIDE OPPORTUNITIES AND HAVE SOME TENDENCIES, BUT NONE WRITTEN IN STONE

GAPS SQUARED

OLD RULE: LARGE GAPS HAVE TO BE CLOSED—NEW RULE: ABOUT 25 PERCENT

Chapter 19: You Must Remember This

IT'S SMART TO BE BEARISH, BUT NOT NECESSARILY PROFITABLE

YOU CAN NEVER KNOW TOO MUCH ABOUT TOO MANY THINGS ON WALL STREET

NOTES

Chapter 20: Wall Street Week and Other Adventures

SALOMON BROTHERS: THE BAR WAS HIGH, EVEN FOR THE CHEF

NOTES

Appendix A: Expansions/Recessions and Bull/Bear Markets

Appendix B: Cost of Timing the Market

DOW JONES RETURN

Appendix C: History of Regulation

Glossary

About the Author

About the Website

Index

Founded in 1807, John Wiley & Sons is the oldest independent publishing company in the United States. With offices in North America, Europe, Australia and Asia, Wiley is globally committed to developing and marketing print and electronic products and services for our customers' professional and personal knowledge and understanding.

The Wiley Trading series features books by traders who have survived the market's ever changing temperament and have prospered—some by reinventing systems, others by getting back to basics. Whether a novice trader, professional or somewhere in-between, these books will provide the advice and strategies needed to prosper today and well into the future.

For a list of available titles, visit our Web site at www.WileyFinance.com.

Cover image: top and bottom © iStockphoto.com / ksana-gribakina; middle © iStockphoto.com / penfold Cover design: Wiley

Copyright © 2013 by Laszlo Birinyi. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data:

Birinyi, Laszlo. The master trader : Birinyi's secrets to understanding the market / Laszlo Birinyi. pages cm.—(Wiley trading series) Includes bibliographical references and index. ISBN 978-1-118-77473-1 (cloth); ISBN 978-1-118-77486-1 (ebk); ISBN 978-1-118-77478-6 (ebk) 1. Investment analysis. 2. Technical analysis (Investment analysis) 3. Speculation. 4. Investments. I. Title. HG4529.B55 2014 332.6—dc23

2013027503

This is for the women in my life; Natalie, Anna, and my wife Jill Costelloe who knows better than most the true meaning of “for better or for worse, through sickness and in health.” For that I am, and will always be, grateful.

Acknowledgments

A large number of individuals contributed to this book: hundreds of clients and accounts who provided me an opportunity to learn and develop an understanding of the market. I hope that they have directly benefitted from the education and will continue to do so.

More specifically, Frank Basile gave me an opportunity to trade when my only attribute was enthusiasm. Jay Mangan encouraged me to develop ideas and aids for traders. At “The Brothers,” MRB allowed me unprecedented latitude in product development, while EO and SS understood the value-added component of what we developed.

More recently, the staff at Birinyi Associates contributed to this writing with a special thanks to Jeff Rubin, my long-time associate, whose prodigious memory and organizational skills were critical to this effort and without whom it would not have happened.

While I am grateful to all of the above, the issues and content are mine alone and any failings or shortcomings are those of the author.

Preface

This is not a book about making money in your spare time, nor does it contain formulas that will allow you to retire early or double your money over the next two weeks. There are no guaranteed recipes for success or easy roads to riches.

Warren Buffett once said about life, or maybe it was the market, that the key was to make a large snowball and find a steep hill. For investors today, both professionals and individuals, the reality is not only that the hill is getting steeper but that it is increasingly uphill.

For a variety of reasons, including technology, communications, regulatory changes, and the like, investing is getting more complex and with complexity comes increased difficulty. Regulators and legislatures would like you to believe that rule changes, new instruments, and other developments have made life easier for the individual. I've disputed that from day one and our research and experience regularly highlight the failings of their conclusions.

Exchanges are no longer quasi-public institutions, but are now busi­nesses. And like all businesses, they have to compete with one another. Brokerage firms' primary focus is on their own, not customers' activity. Stockbrokers have been replaced by financial advisors whose focus is on funds and instruments that provide continuous income to themselves—as opposed to buying a stock that you may hold for five years and that would therefore never generate commissions after day one.

Funds engage in marketing rather than markets, and while I do believe that some of the criticism of professional managers is unwarranted, their failing to adapt and adjust will continue to result in mediocre performance, which is still rewarded with seven-figure compensation.

At the same time, the individual can no longer count on employee pension plans. Now IRAs and 401ks have shifted the burden to the employee and very few individuals have the wherewithal, the education, or even the time to run the financial maze.

This book details many of these issues. It should make you aware of some of the issues every investor faces (including professionals who are sadly unaware of many of them as well). Among our recommendations is education, including reading both current and historical articles and ­writings. The Money Game by Adam Smith, the 1967 bestseller, must be at the top of your reading list.

If money is a game, then like all games there are winners and losers. Hopefully, you will emerge a winner by understanding the reality of today's markets and being aware of the landmines and pitfalls. It is not necessarily a guide to making money but should illustrate what you must do and consider to avoid losing money.

It is also intended for the sophisticated or professional investor. Sadly, one of the characteristics of money managers today is their disregard for the market itself. No longer are ticker tapes a critical input, trading feedback is nonexistent, and history is seldom incorporated or interrogated.

Peter Lynch once suggested that poker was a useful ingredient in the investment process and I would argue that it has been more useful to me than my graduate studies. I have addressed some of the issues that should be incorporated in the investment process:

If futures are down 1 percent, what is the market likely to do that day?A stock reports good news after the close and trades up 10 percent; what will happen tomorrow?What is the best measure of investment sentiment?

Unfortunately, going forward is going to be even more difficult. Issues such as computerized trading, fragmented markets, unregulated blogs, and commentary will continue to obfuscate the investing landscape and investors' lives will become even more difficult.

Having lived in New York City for many years, I never got into golf. Nevertheless, I think that game and the market have some parallels. Very, very few golfers become scratch or even one-handicap players. But someone with a 10 or 12 handicap can enjoy the game, hope to break 80 one day, and play at various courses around the world.

Very few individuals will ever beat the market. Remember that in June 2013 the very best golfers in the world played the Open at Merion and no one beat the benchmark! Most individuals must play the financial game, and hopefully we have outlined and highlighted some of the rules. One which you should tape to your computer was a banner in the Financial Times in the summer of 2012:

Wall Street Always Wins

CHAPTER 1

Technical Analysis: Fuhgeddaboudit

I realized technical analysis didn't work when I turned the charts upside down and didn't get a different answer.

—Warren Buffett

There are three roads to ruin: women, gambling, and technicians. The most pleasant is with women, the quickest is with gambling, but the surest is with technicians.

—Georges Pompidou

Admit it. You were as surprised as I was to find that the former President of France said something about technical analysis. Perhaps it illustrates that individuals who have even a casual interest in the stock market are more likely using a technical approach of some sort. Usually it comes via charts because charts, tables, and graphics are, after all, part and parcel of our daily life. It is easier to show a chart on CNBC, Bloomberg, or in BusinessWeek than GM's balance sheet or income statement. Most market letters are technical in nature, claiming to provide guidance and clarity by reducing all required inputs to a simple, concise graph or table.

Unfortunately, neither life nor the stock market is that simple. We contend after years of analysis and experience that technical analysis does not work.

It is not predictive, it is not consistent, and it is not analysis. While we may not go so far as to compare it to a snake oil salesperson or three-card Monte players, in the ultimate test—making money—it fails.

It fails for a variety of reasons. To begin, it is not a discipline. Unlike the more traditional, fundamental analysts who begin with the economy, examine industries, and eventually look at individual stocks, the technical tool kit is a vast array of approaches and ingredients.

At one recent seminar, the speaker provided a list of technical elements:

Charts: Line & RatioTechnical Studies: OscillatorsBar ChartsTrendingCandle PatternsPrice Pattern AnalysisPoint & FigurePsychologyMarket PictureFibonacciKase ChartsDow TheoryTBL ChartsCycle TheoryElliott Wave TheorySector RotationSentimentBreadth

This list is by no means complete. Over the years, the stock market has been “forecast” by astronomy, musical lyrics, any number of statistical/mathematic approaches, and, lest we forget, the Super Bowl. We would be remiss not to mention an article in Playboy: “How to Beat the Stock Market by Watching Girls, Counting Aspirin, Checking Sunspots, and Wondering Where the Yellow Went” (July 1973).

In mid-2010, investors were warned about the ominous signals coming from the Hindenburg Omen:1

Over the past week, the amount of media coverage given to a rather obscure conglomerate of technical signals called “The Hindenburg Omen” has been extensive . . . it is supposed to be a very bad sign for the stock market.

The word “crash” is frequently found in the Omen forecast.

A Wall Street Journal blog later reported “Yep, it was a dud”, and the market, rather than crashing, cracking, or correcting, gained 22 percent through year end (see Figure 1.1).

Figure 1.1 S&P 500: 2H 2010

Source: Birinyi Associates, Inc., Bloomberg.

INDICATORS: PICK ONE, ANY ONE

The technical analyst/chartist has therefore an abundance of options. Our contention is that too often the facts or indicators support a conclusion; if the indicator changes, no problem, another approach (bearish or bullish) or indicator is inserted.

One approach that we would endorse is to have a consistent process, perhaps beginning with an analysis of the 30 stocks in the Dow Jones Industrial Average (DJIA). A manageable sample that could be regularly analyzed and then supported by some of the other elements listed previously.

Unfortunately, one such exercise only reinforces our argument that technical efforts are of little value. Some years back, Barron's asked three chartists to review the 30 individual stocks that comprise the DJIA:

The first reported that it was indeed “a classic long-term bull” and expected 2,410–2,825 for the rest of the year with an upside target of 3,400–3,425 “possible” over the next twelve months.

The second was a bit more cautious: “supporting one more move into new high ground” with the possibility of a “more serious down” turn in the Spring.

The third felt that eighteen names were bullish with six others neutral. “During the current quarter . . . test the Dow's intraday high of 2,745.” After that “could rise above 3,000” in the first quarter of the next year.

Unfortunately, for investors and analysts alike they were woefully wrong.

October 12, 1987

Analyzing the Dow

Three Top Technicians Size Up the 30 Industrials

Figure 1.2 illustrates and articulates one of our concerns regarding the approach: Technicians have a disappointing record at critical junctures. This applied not only in 1987 but regularly and, sadly, increasingly so.

Figure 1.2 DJIA: 1987

Source: Birinyi Associates, Inc., Bloomberg.

The 1987 Crash marked the end of the great Volcker rally, which began August 12, 1982 and saw the S&P gain 229 percent. At its birth, at another critical juncture, the technical community was also AWOL. It is interesting to review the mood of those times, while the stock market was technically, in a bear market, it was to be a relatively mild decline (losing 24 percent). But the economy was in a recession (which ended in November 1982) and a number of economists suggested that depression might better describe the landscape. Inflation made investors wary of bonds, even as the 30-year Treasury was yielding 14 percent.

The inflation concern was dramatized in the infamous BusinessWeek cover, “The Death of Equities,” shown in Figure 1.3.

Figure 1.3BusinessWeek Cover (August 13, 1979)

Used with permission of Bloomberg L.P. Copyright © 2013. All rights reserved.

Ironically, the magazine was not an inflection point or buy signal, as it was actually published during a bull market (see Figure 1.4).

Figure 1.4 S&P 500: 1974 Bull Market

Source: Birinyi Associates, Inc., Bloomberg.

Less notorious was Forbes' response with their cover “Back from the Dead?” (September 17, 1979).

While the rally's catalyst was Dr. Henry Kaufman's comments on August 17, 1982, the market had actually bottomed the previous Thursday. Over the intervening weekend, a lengthy New York Times article detailed the views of several technical analysts:

Dark Days on Wall Street

The long bear market seems to be entering its final phase. The end could be violent but also cathartic.

A prominent technician argued that the market must first capitulate “. . . a time when everybody simply gives up.” He suggested a final sell-off could come by November, maybe sooner, and the next six months would be critical.

Joe Granville, the most visible member of the community, suggested 550 to 650 by January.

On Tuesday, August 17, the DJIA rose 38.79 or 4.9 percent and traded 92 million shares (the average of the previous 50 days had been 53 million shares). On August 18, a new record, and the first 100-million share day saw volume rise to 131.6 million shares. Despite the gains and activity, chartists were generally unimpressed:

. . . the Dow could well break its '82 low.

. . . an even lower Dow reading, about 680, is anticipated by the end of the month by Justin Mamis, a well-regarded technical analyst.2

One month later, John Schulz wrote a piece for Barron's on September 13, 1982:

Messing Up the Tea Leaves, Where Technical AnalysisWent Wrong

Why did so many pros fail to see it coming? Technical analysis must shoulder much of the blame . . . [technical analysis] offered monumentally bad advice just when—for perhaps the first time in modern history—it finally proved decisively instrumental in shaping majority opinion.

Schulz wrote that the technicians were unanimous in their view that a bottom would be accompanied by “waves of massive selling.” Cash was not at expected bear market levels, and sentiment readings likewise failed to reflect an overwhelmingly negative view. He also suggested that the bearish indicators had become too popular and accepted and therefore discounted.

1990: ANOTHER OPPORTUNITY MISSED

If the chartists were negative in 1982, their attitude in 1990 was even more pronounced (see Figure 1.5). Following Saddam Hussein's foray into Kuwait on August 2, 1990, the market took a sharp, concentrated dive that many expected to be protracted and painful.

Figure 1.5 S&P 500: 2H 1990

Source: Birinyi Associates, Inc., Bloomberg.

Since the decline was event-driven and abrupt, one cannot fault analysts—technical or otherwise—for failing to anticipate the drop. But their reaction afterward is further evidence of our concern that at critical instances, the approach is unsatisfactory:

Analysts Are Reading Their Charts—And Weeping

With virtually every major indicator pointing south, the market slump may stretch well into next year. . . .

How low is low? Some see the Dow touching bottom at 2,200 . . . or 1,700 . . . or 1,444.

BusinessWeek, October 8, 1990

A Bear-Market Rally? It Sure Looks Like One

. . . watches for three signals that would indicate more than just a bear-market rally. Right now he can't detect evidence of even one. . .

Jack Solomon, technical analyst at Bear Stearns, puts things bluntly. The first rallies don't hold. Sell them . . . it's a trap.

Wall Street Journal, November 21, 1990

Analysts: Shades of Nostradamus

On December 24, 1990, after the market had gained 11 percent off the bottom, Barron's interviewed four analysts.

The first expected a “slide toward 2,400 and then a modest recovery to 2,700–2,800.” The second was looking for gains late in 1991 after trading to the 2,100–2,200 level. Analyst number three also thought 2,100 was the next stop followed by a rally to 2,700.

The fourth was the most bearish (2,000, “maybe 1,900”) and then trade in the range of 2,000 to 3,000 over the next four or five years (see Figure 1.6).

Figure 1.6 DJIA: 1991

Source: Birinyi Associates, Inc., Bloomberg.

At the end of the year, the best we can say about these calls is that they tried (see Figure 1.7).

Figure 1.7 DJIA: 2H 1991 through 1995

Source: Birinyi Associates, Inc., Bloomberg.

The Market May Be About to “Start Acting Ugly”

. . . technicians are widely predicting grim tidings for the market . . . some analysts are warning of a possible reprise of the events of 1987.

The market traded a bit lower in November/December (–6.9 percent) so once again the bears were in full cry:3

Watch Out for Falling Bulls

Wall Street's technicians are trumpeting a horrible crash—again.4

(These articles were full-page features, not small, insignificant stories relegated to the bottom corner of a page.)

We cited Mr. Buffett earlier. One indicator that is often cited is the weekly sentiment of the American Association of Individual Investors (AAII). Figure 1.8 shows the chart for the 2009 bull market.

Figure 1.8 AAII versus S&P 500

Source: AAII, Birinyi Associates, Inc., Bloomberg.

Figure 1.9 is the same chart but inverted. As the gentleman from Omaha said . . .

Figure 1.9 AAII versus S&P 500 (Inverted)

Source: AAII, Birinyi Associates, Inc., Bloomberg.

NOTES

1. Michael Kahn, “Taking Stock of a Scary Market Signal,” Barron's, August 8, 2010.

2. Dan Dorfman, “Stock Rally Washed Away,” Daily News, August 27, 1982.

3. Gary Weiss, “The Market May Be About to ‘Start Acting Ugly,'” BusinessWeek, August 4, 1991.

4. Gary Weiss, “Watch Out for Falling Bulls,” BusinessWeek, December 15, 1991.

CHAPTER 2

The Failure of Technical Efforts

Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again.

—John Maynard Keynes

The obvious question is why, given the resources and talents of so many, does the technical approach (in all its manifestations) apparently fail to provide guidance and illumination. As we suggested earlier, the abundance of approaches under the technical umbrella provide a “salad bar” of indicators and tools from which an analyst can choose to support a conclusion.

In addition to a lack of discipline and coherence, technical analysis—in our view—fails for reasons that include:

Amazingly, a lack of analysis.Most analysts didn't, and don't, understand the market.Not recognizing the changing nature of the market, the industry, or the environment.Commentary rather than tangible advice.

It is both surprising and disappointing to find that little analysis and rigorous testing have been undertaken on the various indicators that analysts incorporate in their efforts. Earlier we cited John Schultz's concern that the prevailing opinion at the 1982 bottom required a massive sell-off or, as it was later termed, capitulation.

But why? The previous significant bottom, December 1974, was not accompanied or characterized by investor flight (see Figure 2.1). There was no discernible increase in activity as volume remained about average throughout the entire quarter. Did no one consider that in their strategy?

Figure 2.1 DJIA Volume 4Q 1974 (Shares, M)

Source: Birinyi Associates, Inc., Bloomberg.

Or, we might examine the popular and oft-quoted weekly survey of advisory services, which is tracked and provided by Investors Intelligence.

This indicator is considered a contrary one arguing that if too many individuals are positive, who is left to buy? Also, it suggests that there is the madness of crowds and this is one method to identify when that tipping point has been reached. Like many theories, the logic is impeccable but this is, after all, the stock market.

Historically (back to 1963), the most positive readings of the survey were January 16, 1976 and January 23, 1976, with 81 percent of the respondents bullish, a year the S&P was to gain 19 percent (see Figures 2.2 and 2.3). Later in that same market it was more useful. At the beginning of 1979, investors were bearish as the S&P traded to 100 before staging a rally that was to take it to 130. But as the market rallied, so did investors. We might also note that the volatility of the results is unsettling.

Figure 2.2 S&P 500

Source: Birinyi Associates, Inc., Bloomberg.

A LACK OF ANALYSIS . . . (AGAIN)

Another favored indicator is the number of stocks above their average price of the last 200 days, or roughly ten months. This indicator occurs as the result of many stocks having had a substantial move. The assumption is that it is more likely that the market will pause or slow down than continue higher. It, like other indicators, creates what is commonly termed an “overbought” condition. Conversely, when relatively few stocks have done well, a rally is more likely, creating an “oversold” condition.

The latter is actually true; when relatively few stocks (by this definition) have done well, it suggests that most stocks are doing poorly. Indeed this is the case. As shown in Table 2.1, there have been (in the past 20 years) six instances when only 20 percent of the S&P names are higher than they were—on average—200 days ago. If we measure from when we first breach that measure, in five of the six instances, the market, as we might expect, rallies. It rallies despite the fact that the readings may go lower. In January 2008, at the low, only 1 percent of the S&P 500 names were above their 200-day average.

Table 2.1 S&P 500 Performance After It First Crosses Below 20 Percent

As shown, buying when this indicator is oversold is not only profitable, it is very profitable. To illustrate how much so, we might at this point interject our 5 percent rule. Over the past 100 years, the DJIA has had an average annual price appreciation approximating 5.5 percent. In Table 2.1, buying in August 1998 led to an almost 22 percent return in six months or what would have taken, on a historical basis, four years to achieve. As the cliché goes, that works for me.

What then happens when a large number of stocks are overbought? Using 80 percent as a threshold or indicator of an overbought market, we might expect a correction or consolidation as shown in Table 2.2. In fact, the market becomes even more overbought and six months out has gained well over 6 percent.

Table 2.2 S&P 500 Performance After It First Crosses Above 80 Percent

Thus, buying when the market becomes oversold is, not surprisingly, a profitable strategy. On the other hand, buying when the market is overbought is similarly profitable.

At this point, we might introduce a market axiom:

The market is not symmetrical.

If an indicator suggests higher prices, the reverse of that indicator does not necessarily suggest lower prices.

Our analysis is limited to the past 20 years but other evidence suggests its merit. In 1986, a New York Times article cited the indicator:1

Technical Data Signal Danger

A chart in a recent issue of the Merrill Lynch Market Letter shows that 85 percent of stocks on the NYSE are above their 200 day moving averages of price. . . . Such a high reading can precede a market top or consolidation.

Six months later, the market was basically unchanged, but had presented some trading opportunities and neither topped nor consolidated (see Figure 2.4).

Our analysis of these and other indicators, technical and otherwise, has led us to endorse President Kennedy's comment: “The enemy of the truth is not the lie but the myth.” We will argue that many market conventions and rules are more a function of myth than analysis.

THE ADVANCE/DECLINE LINE: A FAVORITE TOOL, BUT WHY?

Another failing of the technical community results from a lack of understanding. It may appear incomprehensible that individuals who spend many waking, as well as restless, hours dealing with markets, numbers, charts, and tables truly often do not understand them. We might begin with probably the simplest of all technical indicators, the advance/decline line (A/D).

The A/D calculation is a simple one: advancing stocks minus declining stocks (unchanged issues are ignored). As shown in Table 2.3, on July 1, 2011, 466 more S&P names went up than down (the market was up over 1 percent that day). The next day there were 163 more declining names, than advancing, so the two-day total becomes +303 (466 – 163). The process continues and by month's end, the sum of the 20 days was –1,317. Not surprisingly the market was down 2.2 percent over the same period.

Figure 2.3 Investors Intelligence Bullish Sentiment (Four-Week Moving Average)

Source: Investors Intelligence, Birinyi Associates, Inc.

Figure 2.4 S&P 500: 1986

Source: Birinyi Associates, Inc., Bloomberg.

Table 2.3 The Advance Decline Line (A/D) 10-Day Formula

Two notes of caution: First, the results are unweighted, meaning there is no consideration as to the significance, or market value, of the companies. General Electric, for example, is a much bigger and more important issue than Gannett or People's United Bank but it is counted equally. Second, no allowance is made for the size of the move. Ten stocks going up $1 should not be offset by 10 stocks each losing a dime, but in this calculation they are.

Technicians also use the data to create a 10-day oscillator. As shown in Table 2.3 (10-Day Formula), every tenth day is plotted, which creates the chart shown in Figure 2.5. We have extended the data from mid-July 2011 through January 2013. When the 10-day results exceed 1,000, the market is considered extended, or another case of overbought. While the concept has some moderate merit, it is inconsistent. Granted, the overbought condition of mid-July was followed by a decline. And there was some recovery from the grossly oversold reading of early August (–2,500), but the market was to go even lower and traded to 1,100 on October 3. At the time, the indicator's reading was barely negative.

Figure 2.5 10-Day A/D Oscillator

Source: Birinyi Associates, Inc., Bloomberg.

On July 19, 2012, there was a strong overbought condition, but the market actually went up 1.4 percent the next month and 7.6 percent over the next three months.

Its lack of predictive value might also be illustrated by the 1970 bull market shown in Figure 2.6. That market's cumulative result peaked well before the market did. In fact, the market rose another 14.8 percent after the high on April 28, 1971.

Figure 2.6 Cumulative A/D Line: Bull Market 1970 through 1972

Source: Birinyi Associates, Inc., Bloomberg.

This is more usual than unusual. In only two bull markets has the market peaked somewhat in line with its net advances. Yet this is a staple of technical analysis (see Figure 2.7).

Figure 2.7 Cumulative A/D Line Peak During Bull Markets Since 1962

Source: Birinyi Associates, Inc.

The critical issue when it comes to the A/D line, new highs/lows, most active, and many other measures is not how many, but which ones. And the A/D has another characteristic that makes it less useful, which is true of almost every technical indicator endorsed by the chartist community:

Technical indicators are almost universally descriptive, not indicative.

The fact that more stocks went up today than went down tells us that and little more. It does not in any way suggest what will happen tomorrow. That is not to suggest it doesn't have any value, but its value is in understanding, not forecasting.

A market with very broad participation (strong net advances) is difficult to outperform because everything is rising. One must therefore pick the best of the best. In 1999, the A/D line was declining, which most participants viewed as a negative. Strategists and technicians alike were alarmed by the fact that so few stocks were rising and the A/D line was falling, surely indicating an upcoming decline.

In early October of that year, BusinessWeek reported: “Seventy percent of the gain in the S&P 500 year-to-date came from increases in the prices of just 10 stocks.” Other stories also reflected the somewhat unique circumstance:

Nasdaq's Climb: The Air Is Getting Thinner

. . . according to Salomon Smith Barney, almost 40% of the gain in the Nasdaq Composite Index since Oct. 1 can be attributed to only five stocks (Cisco, MCI, Qualcom, Oracle, and Sun Micro).

BusinessWeek, November 29, 1999

Nasdaq's Gains Mask a House Divided, Stocks Show Equal Split of Rich and Poor

71% gain . . . nearly half of all Nasdaq's stocks have actually fallen in price this year.

Wall Street Journal, December 20, 1999

The Bear-Bull Market: As Indexes Soar, Most Stocks Fall

New York Times, December 24, 1999

While any measure of market breadth was disappointing, some managers and analysts recognized the reality and the opportunity: if only 10 or 15 stocks are buoying the market, buy those 10!

Lastly, we would note that the A/D is, at best, coincidental. We have regularly tried to construct a model with the hope of finding some relationship between the number of stocks going up and the change in the index going forward. We were unable to do so. In fact, if we analyze the historical results it is clear that the change in index prices is only tangentially related to the absolute number of stocks that went up or down, as shown in Table 2.4.

Table 2.4 Bull Markets—Net Gain versus Net Advances

VOLUME? ANOTHER IMPORTANT INDICATOR? REALLY?

A somewhat similar circumstance exists for another alleged technical indicator—volume. We have collected a large number of books and publica­tions on the subject of markets, analysis, indicators, and the like. Nevertheless, we have never found a definition of what constitutes good or heavy volume. Clichés such as “volume is the weapon of the bull” have little pragmatic value.

In the markets of the twenty-first century, where shares are measured in the billions and 2 or 3 billion shares is considered a “light” day, it is even more difficult to ascertain what might be critical. But even a superficial analysis of volume in the “good old days” suggests that it was never a critical factor in market forecasting (see Figure 2.8).

Figure 2.8 S&P 500: 10/20/1986 through 6/30/1987

Source: Birinyi Associates, Inc., Bloomberg.

Fall in Stock Trading in Past 6 Months Worries Analysts

Wall Street Journal, October 20, 1986

Slowdown in Trading Volume on Big Board Is Causing Some Concern

Wall Street Journal, March 24, 1988

In this case, shown in Figure 2.9, the market rallied, traded lower, but six months later was higher.

Figure 2.9 S&P 500: 3/24/1988 through 7/12/1988

Source: Birinyi Associates, Inc., Bloomberg.

We suggested earlier that volume is another of the issues that many analysts fail to understand. Specifically, there is the contention that volume in a rising market or stock is good. To illustrate: Assume two stocks have similar characteristics in terms of price, activity, and volatility. One day each stock is up $1 on 100,000 shares. One, however, traded 50,000 shares at a $2 discount before rallying on light volume, while the other name had a slow steady rise throughout the day. The net result for each was the same but there was a marked difference between the two.

Take a classic example American Cynamid (ACY) on December 10, 1979. The stock was the subject of takeover rumors and traded 920,800 shares (five times the norm) and closed up $2.125 to $31.625. By every measure this was a significant, positive development as reflected in ACY's January 30 call options, which rose 32 percent that day.

Upon a more detailed analysis, it was noted that there were 36 block trades (10,000 shares), which accounted for 45 percent of the trading. As shown in Table 2.5, not a single block was affected on an uptick. In effect, institutions sold into the rally, which is also reflected in the fact that there were no especially large trades. Traders were parceling stock into the market, but without completely satisfying the demand. Had they been more aggressive, that is, selling larger blocks, the rally would have been arrested.

Table 2.5 NYSE Block Trader Monitor

Thus, while price and volume on the surface appeared to support a bullish conclusion, more detailed analysis did not. (American Cyanamid was eventually acquired by American Home Products in 1994.)

One technical metric for volume is the 90 percent up or down day. This, we contend, is somewhat flawed as it assumes that the closing price reflects the entire day and that all the volume in a rising stock was positive.

More critical is that is doesn't seem to work. One chartist noted the 90 percent positive as well as increased volume on October 28, 2011 (see Figure 2.10):

Figure 2.10 S&P 500: 9/20/2011 through 12/30/2011

Source: Birinyi Associates, Inc., Bloomberg.

Yesterday's 3.4% rally was a 90% up day on higher volume. Higher volume on a rally is typically bullish.

The charting community also fails because it is slow to incorporate change. Markets, participants, processes, and instruments change. “It's not your grandfather's (or father's) market” is not just a cliché or slogan, but is in fact reality. Concepts such as “stock broker,” “board room,” or even “ticker tape” are history, often ancient history. The introduction of options, futures, derivatives, global markets, ETFs, and even MBAs have revolutionized the business. Add to these increased and faster communications, cheaper technology, and more awareness.

NEWSLETTERS—ONCE UPON A TIME . . .

Some time ago we were asked by Barron's to review the ads for the funds in the paper. In doing so, we were struck by the number of those ads, and by the fact that there were no ads for other services. As a simple test we bought the March 20, 1967 issue at random. There were 47 ads for newsletters including:

ChartcraftDow Theory ForecastsGeorge Lindsay's OpinionGranville LetterJan's WS IrregularLowry's ReportsTechnical StockBuck Investment LetterThe Dines LetterThe Haller TheoryTillman TraderWyckoff Associates

Many of these were prominent, including several full-page ads. On the fund management side there were 12 ads.

In the January 26, 1981 edition, we found 50 newsletter ads and 22 for funds or managers.

Clearly, this reflects the fact that the newsletter advisory business has undergone an upheaval over time. More importantly, it causes us to wonder about the validity of the sentiment survey that tracked their thinking. While it continues to exist and is still published, we have reservations about its validity, relative to decades earlier.

We might also consider the mutual fund cash measure illustrated in Figure 2.11. Historically, when cash was 10 percent of the portfolio, it was considered a contrary indicator. Whether it was or was not indicative of a rally is not important at this juncture. At one time, a billion-dollar fund was a behemoth, and when Gerald Tsai raised almost $500 million it was worthy of the front page. He and others could maintain large cash positions (relative to assets) as a market decision. But with multibillion-dollar funds, having 10 percent cash is a business risk. A dramatic market move (as in March 2009 where it rallied 19 percent off the bottom in less than two weeks) could (and did) leave a portfolio well adrift of the market.

Figure 2.11 Mutual Fund Liquidity Ratio (%)

Source: Birinyi Associates, Inc.

Nevertheless, analysts regularly discuss the low levels of fund cash as being a concern.

PREDICTING RAIN DOESN'T COUNT; BUILDING ARKS DOES

An old, bad story: A balloonist lost control and landed in a cornfield, 25 yards from a gas station, about a quarter mile from an interstate, and across the street from a school.

He asked a passerby as to where he was. “You are at the edge of a cornfield, across from the local high school, and approximately 25 yards from an Exxon station.”