The Chartman, Explained

After many years of trying to explain to people how I trade, I've just about given up. It seems what I do is so foreign to most folks, that I might as well be explaining that I'm a practicing Scientologist. And if they do comprehend a little of my approach, they jump to conclusions and assume I'm a daytrader. Finally, even if they sit down for a few minutes of explanation, they'll sit, ponder and then ask if I think Google (GOOG Quote) is a good buy!

However, I don't blame people for not understanding. If they've never traded or know little about the market, what I do is hard to understand. And, even if they've been in the market, or know their way around Wall Street, the typical person has been so brainwashed by what they read in Fortune, BusinessWeek, Forbes and/or The Wall Street Journal, that my approach is pretty much blasphemy.

Therefore, I thought it might be useful -- one last time! -- to lay out my philosophy of trading.

As I've said many times, I approach trading like a casino approaches gambling. Their approach is to 1) make sure every game on their property provides the house a small edge, and 2) exploit that edge by doing everything they can to attract people to their casino. They are less concerned with someone having a great night than simply staying open and attracting thousands of customers. When a "whale" nails them, they never panic, knowing that over time they will eventually make money.

In a nutshell, that is my approach. Looking at charts provides me a very small edge which I then exploit over thousands of trades. I am not concerned with any one trade, but rather that I have as many at-bats as possible.

In order to get the edge I just talked about, I used charts. Charts, by the way, are just one form of technical analysis, but my guess is they're the most popular. Charts, of course, are nothing more than patterns reflecting the past price and volume on any given day. Those patterns do not foretell the future, but they do give one a hint as to what might shortly happen. That hint is the edge I'm referring to, and the one I exploit in my trading.

Chart reading is voodoo, hocus-pocus, and entails reading ... if what you're assuming is never tested. For that reason, every assumption you make about charts should at least be tested to see if it was accurate in the past. There is some subjectivity involved when it comes to interpreting charts, but other than that, a good technical trader doesn't make a move unless his or her assumptions would have historically made money.

So, what's wrong with using fundamentals? Plenty, so let me highlight just a few problems. One, fundamentals requires you knowing the story. But, you and I are so many layers removed from "the story" we might as well be reading a work of fiction when it comes to an analyst report. I know that for a fact, as the lead IBM (IBM Quote) analyst of a large Wall Street firm used to call me for information about IBM when I worked there (he was a former fraternity brother of mine). I honestly told him what I knew, but I never gave away any inside scoop, as I frankly didn't know any! I was so far removed from what was really going on, I knew as much about IBM strategy as anyone reading the corporate report! (Years later, by the way, when I did get a little closer to those in power and would actually know a bit about IBM's future plans, I'd read an analyst's report and still think it was a work of fiction.)

In addition, for as much heat as chart readers get for trying to divine the future, fundamentalists are really no better. Sure Intel's (INTC Quote) prospects might look bright, but those prospects depend on the economy, competition, employee morale, and about a thousand other forces. All, by the way, unknowable.

My final point, though, is the most important. Use of fundamentals implies getting the story right. Almost by definition, then, you are limiting the playing field of opportunities you might take. Recall from above, though, that's exactly what I don't want to do. Perhaps a good knowledge of fundamentals allows you to make 20% on every trade. But, in order to achieve that success, you might make only 50 trades a year. Contrast to my approach, where I might make 5% on every trade, but make 1,000 trades a year. Which path would you follow?

Hopefully you now understand where I'm coming from. As my wife once said, I am nothing but a gambler. I agreed, but only if she would stipulate that I was "the house" instead of the guy walking in off the street. Remember, casinos are large, profitable businesses built on historical data. That's a pretty good role model for my type of trading.

Tomorrow, more on how I use charts and what patterns I look for in my own trading.

Today, the Dow Jones Industrial Average, Genentech (DNA Quote), Dow Jones (DJ Quote), Yahoo! (YHOO Quote), General Electric (GE Quote) and Intel (INTC Quote).

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Charts produced by TC2000, which is a registered trademark of Worden Brothers Inc.

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And that is the final word Mahwah, N.J., where -- shameless plug time -- I'll be doing a rare, live seminar on Nov. 6. Dan Fitzpatrick, Helene Meisler and Dick Arms will also be there, so see the technical seminar link for details! And don't forget - now is a great time to learn how to make bigger, faster profits with technical analysis and charting. Get a free trial of my newsletter, The Chartman's Top Stocks and follow along with me.