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Elliott Wave Theory – Critique from a Scientific perspective aka my ramblings

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June 17, 2009 – Comments (64) | RELATED TICKERS: EL , IO

Prologue ( You can miss this para if you are ONLY interested in EWT)

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First, I really needn’t do this. However, basically I have an important meeting – and I over-prepared and suddenly have some time to kill, and I love abstract discussions – which I think this one might turn out to be – so you have been forewarned.

 

Additionally, for someone who has been on the Fool for about 20 months – I have to say I am deeply saddened by the polarization in CAPS and how it has recently devolved into the practice of some virulent attacking/mockery etc. So much so – that I made a promise to myself to becoming a silent spectator as far as the Fool is concerned ( For the TMF staff like Jake and Chris – they know that maybe hard for me to do – or maybe they’ll heave a sigh of relief from the absence of the email barrage!) . However as we know – thar is gold to find in the Fool – you need to look and you WILL FIND it.

 

Of course a lot of you do not know me at all – so some pointers. ( This is required – otherwise why would you read – a so-called scientific critique of a pseudo-scientific and proclaimed “Cultish” technique)

 

WHAT I AM NOT

I am not a good trader
I am not an expert in markets
I am not an EWT or for that matter a TA expert
I am not a  “cultist” ( I was one of the first to warn Goodvibe of this potential pitfall – and as I said it saddens me and in spite of all his and other’s efforts – things are taken in a different light!) 

WHAT I AM

-- I am an investor and a “Strategy-lover”
-- I think this really encapsulates my presence in CAPS and outlook vis-à-vis the markets
-- I am a fairly technical and analytical guy ( you’ll realize that much to your chagrin if you continue reading from here)
-- At one point in time ( read last summer) I think I used to have possibly the highest number of recd Pitches ( you know they exist in CAPS, right – other than the satirical?) on Bank stocks ( You might have noticed my name crop up in that adieu blog by Everydayinvestor – with all due respect – do not take me as an expert there either). They were all FA driven portfolio valuations.  You possibly could still find them – otherwise I did a few blogs also, they are still there.
-- I am deeply honored to count within the Fool – people like Mary953, FloridaBuilder, EverydayInvestor, TDRH, Tastylunch, Binve, GoodVibe, DonnerV as my cyber-friends/acquaintances , as well as the TMF development staff– all thru TMF.
-- I am a proud member of the Stinkyfeet crowd ( board – is a disrespect to someone as colorful as madcowmonkey , founder esquire) and the GoodVibe community. The first is a Fundamental (GARP) group , while the latter is mostly TA. I do not know whether you realize that GV welcomes FA – there’s no reason not to.   

Background
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Still there?

So first questions first – are you a believer in TA(Technical Analysis)/FA ( Fundamental Analysis  – or in EMH ( i.e. Efficient Markets Hypothesis)? Or Maybe both? ( How can that be – you ask ? Well I can give an answer – but lets keep that for later) 

Also note that I put FA in the other bucket also – apart from EMH , ie with any analysis at an individual stock level – you are going against EMH saying that you have incremental information that is exogenous to the current stock price.

Of course you need to be at least interested in TA for this blog to be of value to you.Before I begin a little pre-amble on some of my beliefs.

-- Markets are efficient only on Longer-term basis and only to mundane, apparently readily linked information in the short-term. It’s the intermediate where I think you find aberrations either way. I.e. keep Analyzing , there’s no harm. Just know what you are doing

---With any sort of analysis – you need to understand at the end you are essentially trying to fit a “model-based structure” irrespective of whether it was explicitly mentioned or not.

--THE most critical item with these – then become what ASSUMPTIONS are made in such a – “model/hypothesis” – and you becoming cognizant of those

--Models work – till the point of time – THEY DON”T. And its always because of the underlying assumptions  

Critique of  Fundamental Analysis (based models)+++++++++++++++++++++++++++++++++++++++++

First of all I love Ben Graham. As an investor it’s the first book you need to read. It helps you understand in basics how businesses operate – ie to generate profits for its shareholders – and what the key drivers are – again on a general basis. 

The main point you need to understand vis-à-vis most FA based metrics are that they are “post-facto” analysis – they are looking at what already happened. And then using it to “project” ie forecast ( hence model) what WILL HAPPEN – which is ex-ante.

Now you are getting angry with me , especially if you are a “FAist” (that’s of course not a cult – because of large numbers)  - I mean you do your due diligence , nice FCF/DCF etc ( please don’t even get me started with the discounting factor) – and I have the gall to point out a flaw in this. 

Please be patient – I am critiquing – not discrediting or decimating. See when you do all these analysis – what you end up using is a stream of information gleaned from the balance sheet and stored in a database somewhere – and then you are using that prior stream of “Time Varying” information (called Stochastic Time Series , where I come from)  to project the future – and lets say for some reason you use the latest 10Q datapoint to come out with your “Value”. That my friend – is a classic EMH assumption ( not to the stock price – but to the time variant input/driver to your nice FA model) – or called “Random Walk”/ “ Brownian Motion” etc – ie the last data point in time – is the best gauge for the future – again where I come from called an AR(1) [ Autoregressive Time Series model of order 1  - I am lazy – and this is turning out to be much longer than I projected – so am not able to be as meticulous as Hans ( porte) and do linking – please use lovely Google if interested). Oh I am sorry ! You are more sophisticated/rigorous  - like Morningstar – which doesn’t rate anything without 3 year history – well you just moved your time varying parameter from 1 to whatever period you CHOSE ( why may I presume? ) Unfortunately Autoregressive models are by design Trend following – ie they will never catch an inflection point ex-ante. Its those nice graphs on sales pitches which shows Sales projections running up – at a level if extrapolated would mean you are running out of global population real fast!

Net net – you are making an assumption, some big ones – and they are typically unidirectional – just be aware. 

Before I move on – let me also mention one metric from Graham – which is really holy grail and is No-Brainer investing rule. Trading below cash-at-hand. Well if you find companies like that – ie Stock price is below the liquid cash ( or cash equivalents) – then you have practically no risk – and all upside to that level , right?. Well consider this case – what if you have a BIG stakeholder in the company in a foreign country , who did the same analysis and takes a stake based on that same assumption. Company is no great shakes as far as business model ( Kodak , anyone?) – so that Cash is the only reason for investment holding. Local currency appreciates by 50% against the greenback – suddenly that below cash in USD – is above par in Local. By introducing Cross-border exchange risk – I just put in unknown volatility risk in the transaction. Your fellow shareholder may be forced to liquidate – while you sit happy with the hope to parity. Can happen – but stock will tank on forced liquidation. And below cash did not work out for the overseas investor. This can work for you also – see a recent post by Porte – where he contends that US markets are dirt-cheap for European investor – due to this dynamic.If you didn’t have this in your model – you made an INVARIANCE assumption – which was not true.

    

EWP as a Time Series/Neural Network/Systems Dynamics Combo
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You are completely freaked out, right! I am the guy who’s throwing out  “2-dollar” scientific words – just to make this sound legitimate. Just track some tête-à-tête I had with Hans ( Porte) – who is a physicist , on some technical stuff – and maybe your nerves would be calmed a little.  

Elliott Wave – as GV likes to point out to me – is  a “Principle” and not Theory. Essentially it is a conjecture – typical parlance in scientific world – meaning someone proclaims its existence – till someone can refute it with documented evidence.

Let me tell you  - it is almost impossible , post-facto to disprove EWP. Because the graph-structure is so flexible – it will fit any open-ended non-intersecting graph. ( Now you have smile on your face – you non-believer – because you might notice a trace of sarcasm in that last statement!). See this is where EW – is similar to Time Variant N-Nets – it can fit any function in the problem space its dealing with – ie Stockcharts. 

The way to make good N-net models and make them avoid “overfit” issues ( ie where you did a perfect job of matching history – but when you start projecting forward – you are dead wrong! Kinda like fitting to a stock chart series of N-daq from 1997-2000 perfectly and projecting 10 years forward – Dow 40K?) – is to control its “complexity” parameters – ie Keep It Simple, Stupid! ( You possibly read the article blogged by EverydayInvestor on Mebane Faber, I personally tested a variation of the 50/200 MA system with some parameters I built, and yesterday came across one developed by fellow fool salvadorveiga –which looked similar in terms of signals generated – which shows simple TA actually works! Conservative, but works)   EW tries to do this with its “Rules” –  but its still not enough from my point of view – to completely automate this into a model driven structure. Thus making this “individualistic” – and hence cultish to a certain extent. We may come back to this point later – but be aware that we know of one automated EW platform in the commercial domain – and also anecdotally in some Wall St proprietary ones.

  

System Dynamics ( Look it up – MIT Sloan school of thought. Anathema of Economists all over)
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There is a simple basic thing you need to understand about EWP ( Without going into esoteric stuff like Golden Ratio etc)  - it says motive ( ie trend) waves are in 5 parts. 3 in the main direction alternating with 2 in the opposite. With the middle ( ie the 3rd) being the strongest

So if you understand Investor “psychology” – it is stating that in a systemic sense – the bullish sentiment (Buyers)  “loop/cycle/dynamic”  and the bearish sentiment dynamic ( Sellers) – work constantly against each other. In a dominant cycle – the outcome of this system – will subdivide into 5 parts ( sub-cycles or sub-systems) – and each loop will have a variable effect in each of those. ( If you want to understand Sys Dyn  - go ahead – its also fairly conjectural in the sense that you need to hypothesize about the sub-systems and loops and linkages – and then essentially use data to fit a series of partial differential equations to estimate the level of the individual effect) 

One way to estimate the magnitude of these outcome levels is to use Fibonacci Ratios and Extensions ( You could use your own – in the stock market TA does work to the extent , that you need a critical mass of people to follow certain levels for them to be respected – this is a self-reinforcing loop in SD terms. Everyday had a comment of these being random – they could very well be arbitrary – however most recent evidence points to some decent fits. )

Thus depending on the quantity/magnitude of the “extension/retrace” you are getting – is essentially a read on the relative effect the two forces are having on the market trend. So in a motive , you have Wave I – where the new trend gets established  Then doubts start surfacing – some will bail , others hang on , while new believers jump in – Wave II. . Then there comes a strong phase Wave III – clearly established winner now. Then comes “trading profits” – Wave IV – depending on severity and extraneous factors – this typically will be mild ( Flat corrections, Running Triangle etc) – followed by some desperate , ( possibly lower volume) – run up , Wave V.  

EW believes this cycle repeats itself in the micro timeframe also. I think one reason this is becoming increasingly relevant is due to “trigger-happy” trading these days ( Ultralong had a nice blog on this – reading it was like deja-vu for me , because they echoed my thoughts). Little longer term – it is very difficult to refute this structure.

Now from Motive ie Trends – you go to corrections. This is where it becomes messy. Simplistic thinking – Correctives are 3 Waves.SD explanation– is as follows – you have a Dynamic Loop switchover on Wave 4th – essentially what maybe you thought was a motive and started as a 4th count – becomes dominant as switches over. These should be sometimes self-evident on Wave 3 weakness. Thus you essentially have an A-B-C alternating structure in these.    

The MOST CRITICAL point – Trading/Forecasting
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Did I sell you on EW – or have you dozed off by now ( Possibly the later!) ? As I said due to the “non-deterministic” ie if you applied all the EW principles – you will rarely come to “unique” answer – as to what the current wave structure is. There will always be an alternative ( Market will go UP or DOWN LOL!) – however using some of the rules and Ratios – you have a possible framework and can establish Risk/Reward.

That’s it. 

Let me tell you – I have not made a ton of money using EW. There are some reasons – most are due to my lack of time commitment, and micro-management and the other KEY important metric in EW – due to the nature of the Correctives being messy – trying to go against the trend can really burn you.

Its a timing system - if you believe Timing works - there's no rhyme or reason EW won't. If not , well - that OK too. 

Conclusion
===============

---The thing you need to understand about a Trading system ( like say the 50/200 SMA one – mine generated only 54% wins) – it needs just to beat the random (50/50) by a smidge to be profitable.

----I have read and linked ( you need to look for it in GV’s community) – of documented trading evidence on an automated EW platform efficacy – with other TA based methods.

---With a good structured trading template ( used also for the other methods) EW beats others hands-down.

---The trick with EW is to trade the MOTIVES. Correctives are wealth takers – except of Larger Scale.

---No one claimed to be able to fore-tell the market. It’s a trading system.

---Most TA based ( Support-Resistance etc) are Horizontal ( on a graph) methods – with exceptions of MAs, Channeling etc ( which are time series ones again) – which are verticalEW simply combines the Time Series aspect with the Horizontal thru Fib Ratios. 

Whew ! That was WAAY LONGER!!!!!!!!!!!

   

64 Comments – Post Your Own

#1) On June 17, 2009 at 6:41 PM, jddubya (< 20) wrote:

wow - super excellent post!

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#2) On June 17, 2009 at 6:59 PM, anticitrade (99.65) wrote:

Thanks for the post!  That was the best explanation of EW THEORY I have seen on Motley Fool.  Although, as I have previously shown, its not wise to refer to them as cultish.

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#3) On June 17, 2009 at 7:01 PM, anchak (99.85) wrote:

Good that you appreciated antic...... You did tick me off with yours incidentally.....you are still learning - keep assimilating.

All the best with your system!

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#4) On June 17, 2009 at 7:12 PM, Donnernv (< 20) wrote:

Anchak:

Industrial Dynamics was my PhD major at MIT Sloan.  That was the name before Jay Forrester stepped outside of the purely industrial realm to begin pronosticating on things like the world's economic outlook.

I wrote several I.D. simulations covering non-traditional topics like presidential elections (95%+ prediction success) and the dynamics of interaction in three-person groups, for other courses.

I am absolutely convinced that one could write a DYNAMO (or whatever it's called now) simulation that would be quite accurate in predicting the medium to long term path of the equity markets.

For short-term projections, it would be useless.  The input variables are complex, nonlinear and inter-related.  The feedback loops are complex, both of the positive and negative flavors.

But notwithstanding that, they are known or could be posited.  This is where I.D. is ideal.  It permits describing these relationships and relationship curves as precisely as you wish, linear or nonlinear.

The key here would be the ability to backtest to your heart's content for the market as a whole or for individual equities or debt instruments, modifying your model assumptions along the way to yield a better fit to the real outcome.

If I were 40 years younger, I'd tackle it tomorrow.  It would take about 12-18 months and a lot of computer time.

Failing that, I'll just have to invest as Alstry says  :=).  Actually I just do as DonnerDiv does in real life.  It's all about dividend income in this market (which I see continuing for five years minimum).

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#5) On June 17, 2009 at 7:14 PM, mistermiranga (94.99) wrote:

Nicely done. Need more time to take it all in...

I concur on the polarization issue you reference.

 

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#6) On June 17, 2009 at 7:18 PM, anchak (99.85) wrote:

Wow....you ARE an interesting guy Donnernv...... you missed this tidbit in our email exchange.

You are right about the intermediate term - and not short term. The coefficients would keep changing - and continuous alteration - would make it random and useless. However with the longer term trend established - you could develop a trading platform ( ie which will trade on level of change of the derivatives) - I think. I am sure there are a plenty of systems in Wall St which does that. No dearth of Sloan alumni - infact it was a friend of mine - who studied under Forrester who introduced me to System Dynamics. ( You know my background - so you can easily guess where)

I ditto the Dividend investing logic. Infact was just running the screener on that again.

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#7) On June 17, 2009 at 8:32 PM, RussWild (< 20) wrote:

Nice work AC! I became a EWP (not EWT) I do that all the time... when the market would halt of move based on a rule being broken and a count would need to change. It's obvious that the market movers are using EWP in these program trading systems, the real question is how much is EWP used as an overal varible of these systems.

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#8) On June 17, 2009 at 9:37 PM, binve (< 20) wrote:

anchak: AC, that was a beautiful post my friend. I am with you, I myself am a very analytical guy who likes to look at the big picture and the small picture. So why can't FA and TA go together? Why can they not help each other? Why can't people interpret that some tools are best utilized for certain timeframes (FA for long term), or others (TA best for short/medium term, but can give *probabilities* on what the long term *could* look like).

This was a well done thought-experiment and explanation of the value of utilizing *all* tools.

Well done my man!.

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#9) On June 17, 2009 at 11:14 PM, GoodVibe4Ever (< 20) wrote:

Logical, fair, and honest post. Thanks Anchak!

The irony from the number of comments in this post is that those who were crying for logical explanation when they were provided one, only one showed to say thank you but offer no counter critiques of his own! Was he the only one? I promise you that this smart man (even more than myself) who wrote this blog can provide you more if you desire. Give it a chance and comment. There's more than meet the eyes for EW and TA.

I hope this find you well.

GoodVibe

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#10) On June 18, 2009 at 12:59 AM, Tastylunch (29.43) wrote:

Great Post Anchak. really top shelf stuff, this deserves to be top post of the day. One of the best post of the year in CAPS.

I'm very tired but I wnated to reply to such a thoughtful post and I apologize if I ramble or become incoherent.

Re: stepping away from CAPS due to brekadown in civility and meaningful discourse

Sorry to hear you feel that way with what's happened here re:civility. I completely understand though. Personally I expected it to happen given the stress in people's lives with what's happened and the general lowered inhibitions that are prevalent on the web.

That doesn't mean it's  good thing. I'm just less phased by it than most I guess, since I have to deal with it everyday at work. I juts try to ignore it and  go about my business in what is hopefully an additive manner.

Certainly life is too short to be wasted on unproductive flamewars, so I completely sympathize with how you feel. 

Re: fundamental analysis critique

Your criticisms of FA are dead-on. I don't know why you'd think anyone would be mad, You weren't being unfair at all. Most FA users do not account for random unknowable events (famine, meteorites, war, fraud, xchange rates etc) and assume that the model alwasy works . This is why buy and hold investors feel so betrayed, they were being reckless by buying and ignoring which is what most do in practice. Many never bothered to account for the underlying assumptions possiby being violated. This is largely why I went bear in 2008. I saw what I thought were economic conditions that violated the assumptions of LTBH so I went mostly cash.

(BTW Donnernv has a great point imo. Valuations are completely suspect in this market/political environment. Dividend Income is probably nearly a  necessity if one is to risk long exposure in equities for invetsments given the macro situation and accounting opaqueness)

You are right about net-nets. The reason I like them is from a R/R standpoint. When you are wrong you may take a decent hit, but when you are right you are often hugely right in short order if you pick your targets well.

But you are right re: insiders and also the fact that even though a company may have cash on hadn greater than current price that doen't mean they won't find some way to blow it all before you get a chance to realize that cash's value.

RE:Technical Analysis and the EWP

I do think the empirical evidence of FA working is far clearer than with TA however. I think it's devlishly tricky to prove or disprove TA's validity.

I don't know if I'll ever be convinced or unconviced whether TA works. I've wrestled a lot with EW and I'm still trying to figure out whether it really works or not. My experience with Elliot wave so far has been it explains the past very well, but it is not terribly useful in predicting the future. Perhaps that is due to operator error, but it seems to me to be far too open to interpretation to be able to trade very effectively with it. Again though that could be inexperience or ineptitude on my part. I haven't made my final verdict for myself yet.

I do think Fibonacci numbers have potentially very big problems as Everyday pointed out. I don't find them trustworthy at the moment.

That's partly what I like about FA. Eventhough it has all the randomness you mentioned there does seem to be more consistent interpretations of the same evidence by the populace since the methodlogy is more narrow (this is also why I don't use DCF and FCF much although I do value both since RE comapnies use them regularly. I like using methods I see being used in the main street world since I can be confident that my buyer of my asset might use it). When I use FA I'm more confident that I know what someone else thinks of the same stock than what TA tells me.  Thus it lets me feel I understand my potential market for my asset more consistently.

Perhaps that's just a delusion but one thing Goodvibe and I completely agree on is however you invest or trade you have to believe in what you are doing otherwise you won't have the nerve to make good decisions.

All of this makes me wonder if most advanced TA can be useful if different traders trade contrary positions off different counts or different interpretations.

Not sure it's wrong per say, just not sure it's truly usable in a profitable fashion

I tend to agree with Everyday,Re: the perils of confirmation bias and other pyschology issues with TA. The Human mind is very flawed in many respects. I can tell you based off my experiences with customers that person's memory is a very curious and mercurial thing.

It does seem like the simplest TA methods tend to be the most reliable. I know of few long time traders who use Fibs and the more esoteric methods (other than Larry Williams, but then again that guy doesn't pay taxes. He is my next subject I'm looking into, his record with commodities is amazing). But the guys who use SMAs, S&R and evend dollar amounts seem to stick around. At least thats what I've encountered the past 5 years or so in looking at various trading websites etc trying to answer this question.

I've also had far greater success using TA in the extremely short time frames (i.e. less than a day) than weekly to longer. Perhaps I'm just better suited to daytrading than swingtading. 

I'd be curious to know what Jim Simmons basically does. It'd be interesting to see how his Quant fund does things. He is the most successful trader I've heard of, now that Steven Cohen seems to have lost his touch. The newer mega wall street wealthy do seem to be traders unlike the legendary investors of the past who seemed to be value investors/activist invetsors. It mayb ethat modern markets due to electronic trading allow TA to be more meaningfully profitable while reducing a vlau einvetsor's chances asince everyone has equal access to filings etc.

I'm also not sure 54% is enough be really useful given taxes and comission. Unless you have a pretty large profit size to loss size ratio. Especially if you trade Ultras and hold overnight your system can be torpedoed by one bad trade. Heck even stocks anayore can be destroyed like that (look at STSI).

Maybe it is, maybe my last 56-7% system was just too badly flawed re: R/R  :(

Really though to me it all comes down to the same thing,

your asset (stocks, real estatte etc) is only worth what someone else will pay you for it in the future. That's it.

It doesn't matter what rationale you use to value it since it's purely subjective on your buyer's part. Whether they use FA, TA of lucky numbers from Fortune cookie.

The market is always going to have a large subjective component.

 

Wow I dont know if any of that made sense, But I felt I at least you a response  to and a thank you for the post

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#11) On June 18, 2009 at 1:07 AM, Tastylunch (29.43) wrote:

Oh and let me throw some addendums Here Anchak

Here is an academic paper I'm reading on the matter right now, it's pretty d@mning stuff on TA

SSRN-id1181367                                                                                                                                    Report this comment
#12) On June 18, 2009 at 1:17 AM, Tastylunch (29.43) wrote:

And lastly here is an opinon I read a while back that largely is the same as my current view that I'm trying to hold

http://pragcap.com/of-chartists-technicians-fundamentalists

 "....  Also, this is a personal belief, but I don’t view technical analysis and fundamental analysis as being all that different.  When you look at a chart or past data you are essentially looking at the past performance of an asset’s underlying fundamental performance.  For instance, Microsoft stock didn’t go up in a straight line during the 80’s and 90’s because the chart was going up.  The chart went up because Microsoft was consistently growing their revenues and EPS.  In essence, when you see a “good chart” you are viewing the market’s current and past fundamental perspective of that asset.

The harshest critics of technical analysis tend to be fundamental analysts.  You know, the same people who run discounted cash flow models all day using PAST data to predict future prices.  Then they apply some guesses about future interest rates and potential economic conditions (none of which they can accurately predict) and they believe they have applied some sort of intelligent math based solution to the investment world.   They haven’t.

I agree to some extent with fundamental analysts.  As Buffett said: “I realized technical analysis didn’t work when I turned the charts upside down and didn’t get a different answer” and “If past history was all there was to the game, the richest people would be librarians.” - I believe it’s silly to glance at a chart and believe that you can predict the future price of an asset without also looking at a balance sheet or the surrounding economic conditions.   I think most people love charts because they are easy to understand unlike a balance sheet.  That doesn’t make them more useful though.  Rather, the two compliment each other.

It’s easy to criticize anyone who boxes themself into a corner.  For much the same reason that I don’t  only trade one asset class I similarly don’t only use one method to invest.  For instance, I am not a buy and hold investor, but I probably learned more from reading Warren Buffett’s annual letters than I have from any other single investment source.   But I have probably spared myself countless dollars by using technical analysis to implement buy and sell points.   What am I getting at you ask?  Be flexible.   Don’t be critical of someone else’s strategy because in all likelihood you’re using elements of that same strategy in your own.  Likewise, you might just find elements of that strategy useful at some point during this ever changing investment environment."

 I have a lot more to learn about TA before I really can feel comfortable syaing it works or doesn't work with 90% certainty. I really really want to see empirical anlaysis of it that really suggets it works though b4 really espousing it's virtues.So far I'm seeing evidence to the contrary as  I linked above.

Ideally I consider what I try to do with my rl stuff to be light technimentalism, but I have a lot of improving to do, especially on the TA side.

 

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#13) On June 18, 2009 at 1:27 AM, StopLaughing (< 20) wrote:

It appears to me that there are 5 or more major forces in this market.

1. There are large institutions that understand marco economics and the trends that goverment/fed policies create. They often have "superior market intelligence". (Soro is a good example)

2. There are FA traders. I tend to agree that accounting is like looking in the rear view mirror but a large segment of the market trades on this approach. (Buffet may be a good example).

3. There are TA types of various hues. If enough buying power follows the signals that can move the market. 

4. There are large program traders (computer trading models) that trade directly but mostly use intricate hedging models. They do move the markets and create a lot of volatility. 

5. There are small traders who are moved by information (influenced by media and government) who are subject to panic and exuberence.

According to your explaination of why EW works there has to be (1) a rythym between the perceptions of the Bulls and the Bears and that rythym (2) has to repeat in a predictable pattern. 

That set of assumptions (1 and 2) suggests too much  buying power by small traders or it suggests a type of self fullfilling prophecy driven by large traders who expect to see that pattern and then create it.

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#14) On June 18, 2009 at 2:28 AM, timetodrive (< 20) wrote:

Wow, what a post! I would love to add a long and drawn out comment on my views of market analysis, but I feel that everything I have to say has already been said, either in the original post by AC or by the comments left by tastylunch. So I will keep this one shorter than long.

I have predominantly used FA as my method of analysis in the 8 years I have been a self directed investor. This has served me well to a point, but the last year and a half have torn big holes in this method. I think the problem with using past performance to predict future moves does not give a clear picture by itself. This led me to TA.

I have been studying TA which has ultimately led me to the Elliott Wave Principle. I am an artist and musician, but a scientist at heart. In music, I got into producing and engineering because it is the blend of art and science that fits with my personality. EWP has that blend of art and science because it requires human interpretation yet follows scientific guidelines. I am still in my educational phase of EWP, but am seeing the patterns quite clearly and cannot argue with the history and track record.

This post has to be the most intellectual and fairly analytical approach to the subject of methodology I have read on TMF. Granted I have only been on TMF for a couple of months and have only recently started to see the real value here. I have encountered a few members who tend to lash out and make personal attacks, but this is one of the downsides of the worldwide web. I tend to have the attitude that people are who they are and you cannot change them, just put it out there and let others make the choice for themselves. Best to let a-holes be a-holes and not to get ruffled feathers by them.

So, I said this would be short, but look what happened! In closing I say that FA, TA, and EWP all have their place. There is not any one tool that does it all. If I was a carpenter I would not build a house with just a hammer, I would need a tool bag full of tools.

Here is an affirmation that I am striving to live by:

http://caps.fool.com/Blogs/ViewPost.aspx?bpid=212718&t=01008151311953528658

Thanks Anchak for the great post!

Driver

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#15) On June 18, 2009 at 3:20 AM, TMFUltraLong (99.95) wrote:

Man, I feel like the last fuddy-duddy on Earth that uses both fundamental analysis and brick and mortar technical analysis (Edwards and McGee, The Technical Analysis of Stock Trends c. 1966). Personally I find more value and conciseness in the patterns shown in 1966 than I do with all of the scientific parameters established today.

If i had to choose one current tool that I'd keep it would probably be RSI or stochastics. I tend to rely less on relative strength and lean more towards probabilities. Probability in itself means diddly-squat in the stock market, but I've long felt that all things aside, assuming no change in a company over a given period of time, a stock down 7 days in a row has a higher probability of rising than a stock down 3 days in a row. RSI and Stoch does take exacerbated moves to the upside or downside into consideration.

I'd like to think I trade based on an ever-adapting three parameters:

1) fundamentals...history will always play a large part in dictating future events and the human psyche loves to play on history

2) technical analysis: charting can assist with entry and exit points but is nothing more than an adaptation of fundamental analysis. We're looking at past performances and attempting to discern a proper entry or exit point using historical references.

3) gut feeling... I swear this one tends to be the most accurate..lol

Edwards & McGee Technical Analysis of Stock Trends...screw your American Express card, don't leave home without this book and get yourself an OLDER COPY (thats the key!).

UltraLong

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#16) On June 18, 2009 at 6:53 AM, JakilaTheHun (99.93) wrote:

A thoughtful analysis. Yet, it still does not explain some of the major flawed assumptions of TA:

(1) The belief that human psychology can be accurately "graphed" out --- this is the single biggest stumbling block --- TA are assuming that graphs (an imperfect representation of investment patterns) are models for human behavior

(2) The belief that human psychology is so inflexible, that it will not be altered after awareness of any sort of "pattern" develops

It is true that human psychology plays a *HUGE* role in the way that people trade. I will not disagree with that conclusion on any level.

What I do disagree with is the belief that human pscyhology can be systematically predicted by graphs. If it could, there would be TA who were billionaires at this point. And there aren't.

I'm not suggesting that I don't use TA on some basic level. I do look at the charts before buying or selling. I do try to gauge the psychology of the market at times. But what I glean from that analysis is fairly elementary. I try to understand historic valuations and how they fluctuate.

I would say that my fundamental analysis consititues 98% of my rational while technical analysis might constitute 2%. Quite frankly, you don't even need TA. Spending an exboritant amount of time learning a lot of complicated "principles" that probably have no basis in reality is taking away time from analyzing companies on a deeper level and understanding the long-term fundamentals.

There are reasons TA *appears* to work in the short-term. That's simply because the nature of investing and trends. If fear gripes the market, people will sell off and buyers will keep away till stocks hit a certain level, where value investors will come in and grab them. Playing off these trends can create extraordinary gains for high-risk investors. However, that strategy is flawed in many ways.

I've compared TA to astrology, which I think is fairly accurate. But I'll also make another comparison. It's gambling --- but it's gambling by trying to rig the odds in your favor.

When I was 11 years old, I rented "Caesar's Palace" on the Sega Genesis. I was always the mathematical type, so I tried to figure out systems that would allow me to win. I developed one that gave me monstrous gains. The basic premise behind the system is that I would bet a small amount --- say $5 --- and put it on "Black" or "Odd" on the roullete table. I wanted as close to 1 in 2 odds as possible, and "Black" and "Odd" carry 18 in 38 odds.

If I lost, I would simply increase my bet. I could either [a] bet $6 (which would cover the $5 and gain me $1 if I won) or I could be more daring and [b] bet $10 (which would cover the $5 and gain me $5 if I won). If I lost that time, I would bet $12 for my "A" scenario and I could either do $16 or $20 for my "B" scenario. The basic logic was that I simply kept increasing my bet until I won and I would always make a gain.

The strategy worked brilliantly. I actually won millions of dollars on this video game. I wondered if I could somehow go to a real casino and test it out. I never did that because I started thinking about why I was winning and the flaws with my method. You see, there was only one risk from my strategy: "The Big One". That is, a very long streak of losers. For instance, if I bet on "Black" and there were 14 reds in a row. The odds of that happening are incredibly low, but at some point, you would run out of money using that strategy.

Hence, my strategy appeared to work, but in actuality, would eventually come back to bite me big time once the odds caught up.

That's what TA is, more or less. You can ride "trends" and try to predict "shifts", but there is no real science behind that. Sure, basic common sense can allow you to predict this stuff most of the time --- but what about the time you're wrong? TA'ers often convince themselves they just need to modify their approach, but fail to understand the underlying assumptions behind their system are flawed.

Riding trends is easy. Predicting human psychology over the long-run is not. That's why nearly all TA'ers do not outperform the market over the long-run.

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#17) On June 18, 2009 at 7:06 AM, JakilaTheHun (99.93) wrote:

The basic point I'm making is not that TA is completely equivalent to my gambling strategy. There are distinct differences in the mathematical approaches.

What I'm suggesting is that I could convince 98% of the populace that my gambling strategy was infallible. They would see the monstrous gains I made and become convinced of it. They would not however see the very deep flaw in my system. I didn't rig the odds in my favor. I merely found a way that would delay the odds from catching up to me.

I've seen TA'ers wow others with their spectacular gains, but it never seems to last over the long-term. And the ones that do end up winners still never end up with as large gains as heavy fundamentals investors; which leads me to speculate that the few "winners" are merely using some basic common sense and FA along with their TA and convincing themselves there's some magic behind the TA.

After all, how hard was it to really gauge that the market was undervalued at Dow 6500? Or that a company with $10 of net assets and no long-term debt was worth more than $2?

Charts are merely flawed representations of investment pricing. They are not models for human behavior. There might be some "trends" and "patterns", but I've yet to see a comprehensive explanation as to why these trends and patterns are predictors of human behavior.

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#18) On June 18, 2009 at 7:09 AM, ati2ud (31.27) wrote:

Mr the hun,

that's funny to me about the casino. I just got back from a cruise, and lost like you describe. I was playing red/black, and would stay on a color and just keep doubling bets on losses until the color came up. It was working great and all was well until black came up 9 times in a row. I was busted on the 8th but I think the table threw out another one just to show me who was in charge.

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#19) On June 18, 2009 at 8:25 AM, anticitrade (99.65) wrote:

Jakila, funny that you use this example, yesterday I told this same scenario to "millionby24" in his rediculous post. 

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#20) On June 18, 2009 at 8:27 AM, anticitrade (99.65) wrote:

I probably should have included a link to that.

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#21) On June 18, 2009 at 8:46 AM, biotechmgr (36.62) wrote:

EWT, as espoused practiced by Robert Prechter not GV or amateurs, is much more than this sound bite. Like any system, it is not infallible, but it has worked very well for me.

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#22) On June 18, 2009 at 9:36 AM, anchak (99.85) wrote:

Tasty....It wasn't the best blog of the day - till the point in time you dropped by and added your thoughts and the paper/link.

Now it definitely has a shot! Thanks my friend!

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#23) On June 18, 2009 at 9:41 AM, catoismymotor (< 20) wrote:

Wait! EWT has nothing to do with E.T.? Man, I need to spend less time listening to the ramblings of Steven Spielberg.

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#24) On June 18, 2009 at 9:41 AM, anchak (99.85) wrote:

There are lots of good comments and I will need to slowly try to respond - so please bear ( no pun intended) with me !

jddubya , binve,Russ, GV: Thanks for the appreciation. Hope it added some value.

mistermiranga: I echo your thoughts. I will read your blog in detail and hopefully comment.

timetodrive aka Driver: Thanks again! The key thing to understand is the need for balance between competing ( or maybe not?) methods

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#25) On June 18, 2009 at 10:13 AM, madcowmonkey (< 20) wrote:

ac- Ha! esquire, I will have to tell the old lady that one. Don't let the gang wars on caps get you down:) I miss your posts and pitches and you have a lot of information to learn from. Sorry you feel that way.

We all know why EWT is so popular, if you don't, check it out here

I think the main reason for using just one (TA or FA) is that the analyser feels like they have an advantage over their peers. If you didn't think it gave you an advantage, then you wouldn't use it. I guess TA works for people....otherwise we wouldn't have such a large community on caps using it. I don't get too much out of it, but I still like to look at players ideas that do use it. You can  always learn something from it.

My bottom line is that you really have to try and consider all factors when going long and when your a trader the technicals are always a great place to start.  Keeping it simple is the best method for the beginners..... I feel. That's why caps is such a great place to learn. You get to build on the FA side of things (graham) with learning more about TA from players on here and picking up tid bits outside of the site,

 Great post AC. I always like to see posts like this and they are fun to read.

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#26) On June 18, 2009 at 10:22 AM, portefeuille (99.60) wrote:

great post! as I said before, you should post more. still waiting for the next part of your œuvre on options, futures, leveraged ETFs and stuff.

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#27) On June 18, 2009 at 10:23 AM, floridabuilder2 (99.27) wrote:

Anchak,

I come on to the fool blogs maybe once a week now and only look at the top 5 of the day... in any event, glad I caught this and i agree with the polarization comments... just like politics red state blue state...

Hopefully when things settle down I will be able to provide great insight again similar to what you did in this post.

FB

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#28) On June 18, 2009 at 10:30 AM, anchak (99.85) wrote:

OK FOR ALL:

This post is NOT ABOUT whether TA works or not. It really also shouldn't be about whether FA works or not.

This was meant to be a perspective ( personal) on EW - it is fairly abstract in its content.

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#29) On June 18, 2009 at 11:23 AM, anchak (99.85) wrote:

Jakila....I need to point you to a field of Statistics/Mathematics called "Time Series Analysis". or maybe one in Computational Intelligence called "Signal Processing" ( They are practically the same - one deals in the time doman - and the other frequency - ie wave domain)

Does that work ? Why you say - becuase they are myriads papers and scientists out there preaching it. See the good ones know the underlying assumptions and shortcomings - and would be first to admit.

Time-Varying Pattern Recognition ( Which is what the stock market ticker is) - is not an easy problem to solve. When you try to project a stochastic ( probabilistic) series forward - you need to have a level and a time-frame.

TA in a nutshell in math terms is:

Price at time (t) = F ( price at time t-1, t-2, ........t-n) - this n and the shape of the function determines the method and the "Optmizer" you are using - whether implicit or explicit.

With FA you simply try to circumvent/deal with the problem as follows

(i) You use a bunch of explanatory variables - which are the balance sheet information

(ii) You end up using a lot of trending indicators ( like PEG , YonY Debt etc ) - which are time-period differences - ie derived time series variables themselves

(iii) Then use it in a functional form ( whatever you choose) - essentially

Value = F ( x1(t-1), x2( t-1,t-13), x3(t-1, t-4) .....etc)

and then ignore the fact that time periodicity played a role in the projection and Value itself is NOT A STOCHASTIC VARIABLE - and that the price will meet value in a continous/discrete time projected to infinity.

Made it sound RIDICULOUS, DIDN'T I?

Jakila....do not get me wrong .....you can have a great gift for analysis - and your method can be BEST IN CLASS. However there is no guarantee that PRICE WILL MEET VALUE. It is a leap-of-faith. In this way I will tend to trust anitic's system more - because it is automated - so whatever it does it will do consistently. THIS IS THE BIGGEST PEEVE with EWT as I mentioned. More structured thinking is required.

Now to win you over on my side:

I run a portfolio here in the fool called ac360:http://caps.fool.com/player/ac360.aspx.

Its is primarly based on pitches and discussions we have in the Stinkyfeet board - and I am a big proponent of a GREAT VALUE BASED FA METHOD - Joseph Piotroski.

It was also an attempt to use a Hedged Long strategy thru these dangerous waters - you can look at its efficacy and maybe it will add some value to your thoughts.

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#30) On June 18, 2009 at 11:47 AM, anticitrade (99.65) wrote:

Anitic's? I am flattered if this is me. (Although I think I would prefer antic for short, like: "He is up to his usually antics.") Isn't unsettleing when your post gets highjacked and things you said get misunderstood (#28)?

For the record, I am currently working on an appendage to my model that incorporates a type of automated TA based on FA values.

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#31) On June 18, 2009 at 12:22 PM, JakilaTheHun (99.93) wrote:

Anchak,

Many of the top scientists of the 17th century also tried to turn common metals into gold. "Scientists" aren't infallible. They are capable of the same delusions as all other human beings.

Your critique of "fundamental analysis" is based on a bit of a straw man. You say that fundamental analysis relies solely on past data. This isn't strictly true. Certainly, most of the variables and the foundation come from financial statements (i.e. past data), but my valuations are never strictly derived from that info.

Rather, I run future projections to see how different future scenarios could affect the valuation of a company. I also analyze the business of the company and try to come up with future projections of growth. I tend to buy in with a large margin for error due to my own conservatism with money.

While, it's impossible to predict the future, the past is your best guide. If you look at seemingly worst-case scenarios and buy in with a large margin of safety, you can outperform the market over time by a significant margin.

How does this differ from technical analysis? Well ... for one, you have some level of protection. Technical analysis isn't related to the underlying company you are investing in. Rather, one who invested strictly on TA would be solely trying to predict human psychological patterns for a large set of underlying transactions.

The main guide for TA'ers is past charts. From the past, TA'ers try to predict the future. But of what? Of a company? Not really. TA'ers are trying to predict the future actions of an undefined group of traders based on the premise that all human psychology will be relatively similiar over time and can be fully understood and explained by charts.

Certainly some TA'ers fare better than others. The ones who understand portfolio strategies and have some comprehension of risk-reward will do better than the ones who don't over a long period of time. The TA'ers who do not base their analysis solely on technicals, but also look at the fundamentals will fare better than those who don't over the long-term.

But here's the real question --- which group of TA'ers would fare better over time: the ones who dogmatically use charting in order to predict future market behavior? Or the ones who inject their own common sense and their own understanding of their own emotional reactions to their analysis?

My issue is this --- unless a computer can analyze the charts and predict with an extremely high rate of accuracy the patterns of the future, how do you know that TA is actually working? How do you know that this isn't basically the case of the brilliant scientist who thinks he can turn a common metal into gold? Or that is to say, how do you know the individual using TA isn't simply convincing their self it works when in actuality, it plays virtually no positive role in their performance?

You can obviously argue that FA creates the same conundrum --- except that's where the argument would fail, because on a basic level, when you buy a stock, you are buying a company. You actually own a share of assets and earnings. If you purchased more than 50% of the stock in a company, you could take it over and pay out 100% in dividends to yourself, which would actually entitle you to those earnings.

Would you be so confident in buying out an entire company based on the signals a chart gives you? Probably not --- I don't think any TA'ers would buy out an entire company just because the chart said the stock was going up. So in a very real sense, TA has no real solid footing on which to stand.

You can convince yourself it works. On some basic level, I think all of us can glance at the past charts, take our own understanding of human psychology, and apply it forward. I'll even argue that this can be beneficial to one's own performance. But I wouldn't argue that by merely coming up with elaborate methods for studying charts, that you can somehow predict the future.

This is why I believe TA is more or less equivalent to astrology or Miss Cleo's psychic readings. Humans are very good at convincing themselves things work sometimes, even when there's no real rationale as to why it would and basic logic would suggest that it doesn't. You can't predict the future of a stock any more by reading a chart than you can predict the future of your own life from a deck of tarot cards.

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#32) On June 18, 2009 at 12:24 PM, anchak (99.85) wrote:

Incidentally....if you guys ever get the chance to read Piotroski's paper ( or the new addendum - which Everyday had linked - which showed cash held did add incremental lift) - did mention one tidbit - which is not often discussed:

The class of stocks that scored Higher and the class of stocks that scored Lower - had a Statistically different return expectation and the Higher scoring stocks beat the index also - however the lower ones - also HAD A POSITIVE RETURN!

People just walk away saying - well then Long-Short doesn't work with Piotroski.

However I personally see this problem - essentially the metric was able to discern what's called a Between class variance- however not so much of a spread to identify stocks going down in value.

Ie the Expected return is then CONTINGENT upon what the market returns - and the class difference would be relative to the Index - EXACTLY like how MF scores picks!

Please be clear that Piotroski does not purport to do the above - so there's nothing wrong in the approach. Hence you will see most of my boatload of picks (Long side) - happened between 3/2-3/9.

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#33) On June 18, 2009 at 12:28 PM, anchak (99.85) wrote:

Jakila...you have it wrong....you just basically rephrased what I said - and ended up disagreeing with me! We are on the same page - and do not take this personally - as I said you may be the best Valuation Analyst in the world - and if so - I would some day line up at your door trying to get you manage some of my money.

I do not typically follow a singular strategy - should be obvious.

anticitrade: Correct approach. It definitely could add some value - especially if done mechanically without bias.

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#34) On June 18, 2009 at 12:33 PM, anchak (99.85) wrote:

UltraLong: Good to see you here!

I will definitely check out the book - maybe Amazon marketplace will have the correct version?

The point about Stochastics ( and also the example by Jakila) - is very valid - its essentially a RUN problem ( especially Jakila's - which in cards - is a Bernoulli/Binomial/Multinomial issue - so clear mathematical construct) - but even for stocks - even you believe peusdo-randomness - you should expect a break of the run.

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#35) On June 18, 2009 at 12:33 PM, anchak (99.85) wrote:

UltraLong: Good to see you here!

I will definitely check out the book - maybe Amazon marketplace will have the correct version?

The point about Stochastics ( and also the example by Jakila) - is very valid - its essentially a RUN problem ( especially Jakila's - which in cards - is a Bernoulli/Binomial/Multinomial issue - so clear mathematical construct) - but even for stocks - even you believe peusdo-randomness - you should expect a break of the run.

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#36) On June 18, 2009 at 12:39 PM, anchak (99.85) wrote:

biotechmgr: I have seen you call stuff - fairly consistently - and you clearly seem to have used this before. However your statement tries to shroud this in mystery - which I think is wrong. I think it maybe has got to do with your own instinct - rather than what Prechter's book has.

The method from a pure technical perspective is what I mention - and what people are extremely concerned about. It does 100% post-facto fit - which immediately leads people to distrust what it does ex-ante. Structured thought is key ( which you claim to have) - and possibly a certain degree of computerized automation taking away bias in my view.

catoismymotor: Nice joke! Would have loved to see some comment about the topic though

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#37) On June 18, 2009 at 12:43 PM, anchak (99.85) wrote:

Hey Tasty....on the 54% success ratio thing - man you should read the Mebane Faber paper -

This strategy if you started investing $100/wk from 1928 - till today - would have more than doubled the market gains. Its like 4500% return as opposed to close to 2000% for Buy-and-Hold indexing. ( Of course compounding has a role to play!)

Essentially it keeps you out of the Bears claws - and keeps you in the Bulls.

I am going to read this paper

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#38) On June 18, 2009 at 12:46 PM, anchak (99.85) wrote:

Madcow....Nice thoughts - we are basically reinforcing our own collective beliefs here ( confirmation bias as Everyday would say)

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#39) On June 18, 2009 at 12:49 PM, anchak (99.85) wrote:

Hans......its tough man! Also too much market gyration - has great perils for those strategies.

FB....Good to see you here. Send me an update once in a while in email if you can. I will let you know of some developments happening at this side.

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#40) On June 18, 2009 at 12:51 PM, anchak (99.85) wrote:

Whew ! I think I covered everyone - at least for now

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#41) On June 18, 2009 at 12:57 PM, anchak (99.85) wrote:

Incidentally,

DIVIDEND Investing strategy is much safer in this environment. Since let's recap what Tasty says here:

"your asset (stocks, real estate etc) is only worth what someone else will pay you for it in the future. That's it."

Thus with a forward looking - unbounded outlook valuation - the more time passes - the more your capital loses value - unless its keeping up with inflation,market return etc.

A steady Dividend - is cash flow at hand - so you are being compensated for the wait. Please look into TMFHighYield - for a pure div strategy.

The key variable there is the probability/risk to the dividend over your hold horizon ( lets say 5yrs+)

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#42) On June 18, 2009 at 1:06 PM, PrestonCheek (32.84) wrote:

Great post AC.

Preston

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#43) On June 18, 2009 at 1:21 PM, anchak (99.85) wrote:

JakilaTheHun (99.91):

One of my bosses once said to me : "You can't change people who do not want to change" So I will not endeavor to do so either.

Clearly you are riled up on this topic. Your tirade in on TA - and you try to give a lot of evidence saying it doesn't work. You claim you have superior FA skills - See I DID NOT try to refute that in any way.

Yet most people understand both methods try to do the same thing - its just the information ( ie explanatory variables from a model standpoint) used are different. Time Series methods and Regression based methods ( which ignore time typically) - coexist.

TA is obviously simpler - as Tasty says most people can follow charts.

And I WILL LEAVE WITH A CONUNDRUM ( I know this to be true) -

http://finance.yahoo.com/echarts?s=GE#chart35:symbol=ge;range=19951002,20090617;indicator=sma(50,200)+volume+macd;charttype=line;crosshair=on;ohlcvalues=0;logscale=on

This is the long-term chart for General Electric. Not an easy business to value . If you invested in GE based on the 50/200 crossovers or Discounted Value metric - would they have generated ENTRY/EXITS at the same time-periods?

The Crossover trumps Buy-and-Hold incidentally, its obvious. And also do not tell me fundamental valuation would have forewarned you about the plight of GE aforehand.

I looked at their balance sheet - all the way thru. Their portfolio quality was not generally impaired ( except their non-prime concentrations - because GE mostly does mezzanine business) - what really got them stupified was the vaporization of fungibility between businesses - they use other businesses might to provide low cost funding to GE Capital. And then it got compounded on asset-deterioration in their consumer finance businesses.

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#44) On June 18, 2009 at 2:05 PM, JakilaTheHun (99.93) wrote:

Anchak,

I'm not "riled up" in any way, shape, or form. I've merely made an argument as to why TA doesn't have any solid footing to stand on. You've interpreted it as "riled up", which I would suggest might have more to do with your own state than mine.

You are, however, simply repeating the GV strategy, which is simply claiming that anyone who doesn't agree with you just be close-minded and bigoted. Why do I reject TA? Because I've never heard one logical argument in favor of it. Nor do I see any evidence that it allows people to consistently outperform the market.

I don't claim to have "superior FA skills". I merely know that on a basic level, fundamentals drive valuation. Hence, I analyze those fundamentals. My success or failure in that endeavor is debatable.

As to GE, I believe your argument is somewhat nonsensical. Are you suggesting that TA could predict GE's decline, but FA could not? That's a rather strange argument since you are basically suggesting that a chart would predict an outcome, but the individuals analyzing a company could not --- yet, how did the deteriorated fundamentals get detected in the first place if not by those analyzing the fundamentals?

I don't buy into many large cap conglomerates. GE is a good example as to why. When a company is that large and sprawling, there's no realistic way to come up with an accurate valuation for it.

But your claim that 'no one saw it coming' is a bit ludicrous. Nearly 2/3 of GE's profits came from its financial services arm, GECS. I invested in GE early in 2008 only to sell out after becoming fearful that carnage would result from that. GE is heavily levered and much of their profits were imaginary. The market woke up and realized this. Did it overreact? Yes. It normally does.

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#45) On June 18, 2009 at 3:12 PM, anchak (99.85) wrote:

Jakila has a blog on this. I responded there too.

http://caps.fool.com/Blogs/ViewPost.aspx?bpid=214969&t=01001094457128408726

Its a pity how things devolve fast here.

Tasty...I will read the paper - and maybe leave a comment. I think Everyday had linked a prior paper on TAs which used similar Bootstrapping ( or Resample based) strategy and I had a response ( in fact I emailed the author - never got back).

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#46) On June 18, 2009 at 3:49 PM, anchak (99.85) wrote:

Tasty....here's the link to the paper Everyday linked

http://caps.fool.com/Blogs/ViewPost.aspx?bpid=148823&t=01001529370998141183

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#47) On June 18, 2009 at 4:55 PM, anchak (99.85) wrote:

Tasty....Comment on the paper. Very very good one and you need to buy their premise.

Observations:

1. Period tested was Jan 2001 to Dec 2007. ie trail end of a bear to beginning of one. This is good because hopefully their Bootstrap resamples - generated enough GOOD price paths for the indices

2. One would have liked more than 500 resamples. Computing limitation I would guess.

Key questions in my mind:

Look at Table 3& 4. Essentially TA rules that are simplistic and does not generate multiple signals - does pretty well.

Here - they mechanically chose the max for each market and say well each rule is randomly plausible.

Question is - as they say - if you look at Developed markets and realize that Support-Resistance rules do generally well ( They are decent even in Emerging markets - may not exactly be the max) - and then restrict your rule-set to those only - would you still have large-sample randomness ( rules becoming insignificant only on data-snooping check - which means I am equally like to choose from 5000 trading rules at any point in time)

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#48) On June 18, 2009 at 10:50 PM, madcowmonkey (< 20) wrote:

I thought "antici"trade evolved from "antici"pate. Wrong again:)

AC- confirming is a funny thing. Probably one of the poignant statemants on here:

5000 trading rules at any point in time 

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#49) On June 18, 2009 at 10:59 PM, anchak (99.85) wrote:

I hear you madcow.....things get murkier or may be clearer - I really do not know which anymore.

and I did think it did evolve from aniticipatory trades -

He's an OSU alumnus.....

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#50) On June 18, 2009 at 11:25 PM, anticitrade (99.65) wrote:

Madcowmonkey:  Actually you are right.  We chemically reacted anticipation with trading and got anticitrade.  Although we have also been confused as being Anti-Citrade...  But in fact, we have nothing against citrade at all. 

Before the creation of the website, I referred to the original model as the "ASP" (automated stock picker), it allowed me say stuff like:  I just pulled that stock out of my ASP.  Which was the source of great personal amusement during my MBA at BYU.

What does my time at OSU have to do with anything?

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#51) On June 19, 2009 at 9:21 AM, madcowmonkey (< 20) wrote:

anticitrade- that's funny, because I usually just say that I pulled it out of my ASS (advanced shortcoming system). Not real funny, but that is all I got on Friday morning. BTW- I think ac was just seeing if you would ask this: "What does my time at OSU have to do with anything?" It doesn't..... unless it is Oklahoma instead of Oregon:)

ac- I hear ya. I have been confused on my feelings lately. That is why I wrote the "Checking the condition my condition is in" blog. Oh well. Too much other stuff going on to worry about my sappy feelings anyway.

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#52) On June 19, 2009 at 9:34 AM, anticitrade (99.65) wrote:

Hey! It WAS Oklahoma! What could Oregon possibly have on Oklahoma? (Jk I do not want to go there... At lease we are not THE Ohio State)

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#53) On June 19, 2009 at 9:34 AM, madcowmonkey (< 20) wrote:

ac- link and link

can you imagine why I like thestinkyfeet premise. Add in Craig and the love for dividends and I think the information/selections given gives back decent returns for the future.

 

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#54) On June 19, 2009 at 11:04 AM, madcowmonkey (< 20) wrote:

OOOOOh! A comment about Ohio can bring out some serious retalliation:)

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#55) On June 19, 2009 at 11:54 AM, anchak (99.85) wrote:

Good links Madcow..... Of course I linked the actual Piotroski paper in the board.

The second one's argument is compelling ( I think the main issue would be volume ie size of capital) - for individual investors like you and me - this is a valid proposition

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#56) On June 20, 2009 at 1:45 AM, Tastylunch (29.43) wrote:

anchak

Hey sorry for the lengthy delay in response. Reading your excellent responses just reminds me how much Math and Statistics I've forgotten since school. I feel very rusty so please forgive me if I say something that's  inaccurate.

I agree with your interpretation of the paper. TA is very hard to verify it's usefulness and I don't think the paper conclusively proved that all TA doesn't work, just likely most of it.

The big big shortcoming form the paper was their inability to include volume based methods(!  on page 8) due to inaccessibility of such data in some markets.

Also critically they did not test the rules in conjunction with FA methods (i.e. A piotroski + S&R trade)

Also how you frame that question ("does TA work?") is critically important.

E.g. Scaling. A lot of  the most reliable TA methods I've encountered do not Scale very well at all in my experience. They work great if keep it to 3-5k and use market orders in very liquid markets (so market makers don't screw you since they and others can "see" what you are doing)

E.g. Time Frame-  If A TA method works for a number of years due to random chance and you get outsized returns because of it did it truly not work?  Academically I'd say it didn't, but if you were able to profit from it I suppose from a human perspective you could say it does.

I've seen people go on incredible runs over a number of years and then go cold. However the best traders I've met ride a method until it stops working and then they switch/search until they find a new one. It's bit like the hot hand theory from sports (which has supposedly been disproven but I'm not convinced since there is such strong  mass belief in it by players, they generally get upset if the "hot hand" is removed).The Best trader I've met has used three-four completely different methods since the 1960's. He's very adaptable.That goes counter to everything I've ever heard(that you must be rule based trader and stick to it good and bad) but the best seem to be that way. Perhaps it's just due to an incredible string of luck and it's just random noise.

I'm glad you found the paper interesting. I've been rereading it several times.

The biggest takeaway I got was the same you did

is that the simpler systems are more likely to work than complex ones , incidentally this is what Everyday and the pro daytraders I know believe as well. S&R. Golden crosses. Even dollar marks. That's about it. (Craig incidentally has a portfolio on CAPS just using SMA crosses on here I believe)

No Head and shoulders, no cup with handles, no Fibonaccis, no TRIX etc etc.

Really bums me out since I really like the Williams %R

All this does is add fuel to my doubt of EWP, to bring the topic back full circle. EWP is undenialbly less straightforward than S&R and golden Crosses etc to employ as a trader. It may just be too open for a human to trade. It provides so many answers with such flexibility that it's basically always right in retrospect.  I don't know how to trade that.

The more I look at EWP I really think it does describe market behavior but it may not tell you future market reliably enough to trade off of.  Perhaps it's best use might be to tell you the potential length of what your trade should be (e.g. if you are going long in a potential Wave 3 to let it ride for a good while)

I'll have to see if I can find that automated program you describe, I'm curious to see how it works with EWP

On a related note:

I have a working hypothess that TA works better in derivative markets like commodities than equities. Those markets are driven more by speculation than fundamentals so it would make sense to me that they would reflect mass psychology more. It might be a self reinforcing issue there as well as TA is more heavily used by Forex and Commodity traders.

Also the wealthiest chartists I've heard of  tended to be commodity  or forex traders (larry williams, the original turtle trend traders etc)

It'd be interesting to see if someone has done a study on that. Report this comment
#57) On June 20, 2009 at 1:56 AM, Tastylunch (29.43) wrote:

madcowmonkey

Yeah Anchak's Piotroski picks have been some of our bggest winners. We probably ought to add some more.I know Craig like Growers but I really do think you need both Value and Growth exposure sicne you never know which one will be in vogue.

 I had read the first paper you linked but not the second. Very very interesting.

 

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#58) On June 20, 2009 at 4:30 AM, dexion10 (27.77) wrote:

anchak thanks for this post - glad to see you are still plugging away here in CAPS

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#59) On June 25, 2009 at 6:04 PM, TigerPackFund (< 20) wrote:

anchak-

I hope you can participate in the new "collective" picking system portfolio we have devised for a small group of Top CAPS members. Click below to read the blog under the new TigerPackFund member name explaining our effort:

http://caps.fool.com/Blogs/ViewPost.aspx?bpid=215551&t=01008389776301665428

We could absolutely use your smarts and experience to generate a higher return for readers.

We are basically asking you to pick up to 5 stocks at time, under the normal CAPS rules and scoring system. Our goal is to find a solid group of 40 members who have proven themselves already, to be our regular contributing stock pickers.

-TigerPack

(This message may be a repeat to one of your blogs, I can't remember if I put one your blog area or not.)

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#60) On June 25, 2009 at 9:02 PM, anchak (99.85) wrote:

Hello Tiger...I already said I would - just to network with you. You would have received my picks - except I am extremely confused with the ongoings with the market currently to call anything.

Nevertheless I will try and send you an email - and maybe get formally introduced.

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#61) On June 25, 2009 at 10:20 PM, TigerPackFund (< 20) wrote:

Terrific, I will hold a spot for you and put your CAPS name on the TigerPackFund Favorites list. This tab will act as a quick guide of the contributors.

It looks like we are getting a good group together.

Email directly whenever you have a strong idea to select.

-TigerPack

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#62) On June 30, 2009 at 12:57 PM, madcowmonkey (< 20) wrote:

Didn't madoff only allow a select criteria of individuals into his ponzi scheme. Watch out for those people that are overly selective:) All in fun of course.

Here is the excerpt I agree with the most from the Pitroski link:

The research also shows that a majority of the high B-to-M portfolio's winners are firms with low share turnover and no analyst following. Consistent with those general observations, further analysis shows that Piotroski's investment approach works best for small- and medium-sized firms, thinly traded firms, and firms with no analyst following. Moreover, the success of the strategy does not appear to be driven by purchasing firms with low share prices. 

 

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#63) On July 15, 2009 at 1:17 PM, madcowmonkey (< 20) wrote:

ac- I saw you on earlier, so I figured I would put up another bug.

Click on any pitch for any stock that is rated by a player as outperform. When the new screen pops up it is now an underperform with a red thumb pointing down. Nothing serious, but it threw me off the other day:)

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#64) On July 15, 2009 at 1:18 PM, madcowmonkey (< 20) wrote:

woops:) wrong blog.

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