The Basic TheoryThere is quite a lot of conjecture about how charts work, but they all boil down to this: The actions of everyone who has done their homework on a stock shows up in the chart. Let's take the manager of a value fund. This person's methodology relies on fundamentals. He finds a stock he is interested in. His mutual fund has an enormous research budget and tools at its disposal. They put their staff to work, visit the company, speak to senior management, check the channels -- i.e. speak to vendors, suppliers, and customers -- to see how the company's product is selling. After they run through a long checklist, they decide to add the stock to the fund's portfolio.
Footprints of ElephantsYou see, there's a crucial difference between a fund and an individual investor. When you make a buy decision, the odds are you pick up a position of a few thousand shares (at most). That's it! The stock either works for you or it doesn't. Funds are different. They don't merely buy stock -- they build positions; huge, enormous, institutional-sized positions. Mutual funds receive constant inflows. They are always putting their money to work, on a regular basis over time. When most investors buy a stock, it's a single decision, a single point in time. The purchasing process by large funds occurs over a much longer period. Some positions can take months if not years to build -- or unwind. Note that the process works in reverse when firms are selling a stock. The technical terms for the process of institutional buying is called "accumulation"; institutional selling is called "distribution." Institutions account for 90% of the NYSE stock market volume -- and half of that is done by the world's 50-largest investment firms. These funds are like elephants -- huge, and secretive in nature. They don't want the world to know what they are buying, because they fear traders will front-run them. If you could buy a stock before they can, it would cause the funds to pay a higher price, thereby lowering performance. But elephants leave tracks in the jungle. They may be secretive, but their enormous girth means that they can be tracked. The same is true for institutions. Don't you think that knowing what these behemoths are up to can help you in the markets? If we know that once they buy a stock, they will keep buying it, isn't it a valuable piece of information to know what they are buying? Knowing what they are selling -- and will continue to sell over many months -- is even more important.
|1.||Expect to Be Wrong||2.||Your Fault, Reader|
|3.||The Wrong Crowd||4.||Bull or Bear? Neither|
|5.||Know Thyself||6.||Prepare for Battle|
|7.||Bite Your Tongue||8.||Don't Speak, Part 2|
|9.||The Zen of Trading||10.||The Folly of Forecasting|
|11.||Lose the News|
|Check back for more of Barry Ritholtz's |
Apprenticed Investor series
TA: The BasicsYou do not need to become an expert technician to improve your investing. If you learn only a few basic things about charts, you will enhance your returns significantly. Think of technicals as the "when" part of your strategy. Fundamentals are very good at telling you "what" to buy, but they are less proficient at telling you when to buy. The example we used
|Auto Wreck |
Ford's chart shows in grim detail why you must avoid buying stocks in a downtrend
|Source: Barry Ritholtz|