(Editor's Note: I just want to thank everyone for all the emails the hundreds of comments from my last post; I have some serious reading and studying to do this long weekend! – Tim)
This post is a re-tread from my blog. I posted this originally in April, 2008. This represents a generic piece that I wrote to ground my thinking. With some much editing, I thought that it might be a nice piece to share particularly in light of Tim's recent post, though I've been trying to re-edit this thing for a while. I apologize for the length. The genesis of this post was from a reader's comment about what to follow to divine stock market movement–on what basis are we to judge the direction of the market?
As market participants and technicians, we are shaman-like in our quest for determining stock market direction. Our technician's tools are our talismans: we shake, rattle and roll the various chicken bones we lovingly call our indicators; we raise our moistened finger to see which way the wind blows; and we gaze wistfully to the horizon to see whether the clouds are fair or foul. To supplement our efforts, we look thoughtfully upon the past and what the ancients said and thought. Market Shamans… a strange, but apt, metaphor I think for our attempts at market divination.
Carlos Castaneda went on a peyote-inspired walk through the desert with his eyes crossed to find "truth" somewhere in the field of his overlapping vision. Technicians employ a number of means to do the same. The complexity of the layering of divination tools (a/k/a indicators) combined with sentiment, insider buying/selling, cycles, eclipses, and Mercury retrogrades! has the capacity to produce conflicting signals leaving one standing in the desert of indecision with one's eyes permanently crossed (just as our mothers warned). Perhaps there is a chicken bone or two poking a hole in one's pocket or in a tender area (or two!). I'm not arguing against these technical talismans, but rather cautioning that at some point one saturates oneself with so much information that it is an overload and may not produce clear signals for action. Esoterica, while pleasingly seductive, can occlude our vision.
Nevertheless, that desert is one that every technician/trader must wander. And while 40 days is significant in religious texts, aspiring market technicians will need more than 40 days of quality desert time to cultivate their skills and develop their insights. Insight. Think about that word for a moment (courtesy of Dictionary.com), and I'll get back to it upon the close.
There are many systems, simple and complex, that a technician can avail her/himself to. Oftentimes, there is a sense that the more complex and esoteric a system is, the more accurate it must be. We expect our prophets of market direction to have access to a powerful knowledge that is not in the hands of us mere mortals. The only esoterica worth understanding is that markets follow not so much reality but the perceptions of reality by market participants evidenced by the each day's volume and price prints. We know that there is a large disconnect between the two. If our technical tools are applied to fickle perceptions, how can we expect, much less demand, precision–both of which are voiced frequently? Our modern tools developed for MEASURING historical market data, do not have any power for FORECASTING market direction. It is for us to have an understanding of what the probabilities are of one direction over another. And while there may be a 75% probability of x happening over y, there is a 100% probability that only one of them will happen.
I believe that money, like water, seeks its own level though there may be wide swaths of disparity for uncertain durations. I believe that the following things matter a great deal: macro economics, an understanding of intrinsic and extrinsic value in stocks, business/debt cycles, and market participant psychology as well as our own psychology. The market, as with ourselves, is trying to divine the future. It uses its own talismans, technical, fundamental, sentiment all cobbled together to form some sort of roadmap. It does not have all that great a record at forecasting or pricing accurately, but it is constantly seeking price discovery. It is voracious in gorging on a steady diet of news–some of which gets digested easily, and some of which results in a smelly gastronomical event that defines our significant bear markets.
Our market participants are all manner of smart, experienced and successful folks: inflationistas, deflationistas, bond vigilantes, gold bugs, bulls, bears, value investors and contrarians, each believing that they have some special understanding that others simply don't get. Realistically, they cannot all be right at the same time. Ultimately as technicians, in the purist sense, we are merely spotting the consequences of their money actions v. their espoused opinion by noting three things on which we can incontrovertibly rely: quantity and allocation over time.
Strong trends get weak and weak trends get strong depending on a number of quantitative and qualitative factors–none of which we have control over. Nevertheless, some still demand that our charts forecast the future. When the future 'promised' by a chart set up evaporates, there is a broad lament (by those who are caught wrong-footed), "Technical analysis has failed." It is not that technical analysis, but rather that we have failed in our understanding of its limits. But even though limited, technical analysis has a great power. I believe that power lies in giving us a means to cultivate our market insight.
Technical analysis is the language (or music if you are more romantically inclined) of the stock market. Justin Mamis tells us that the market is always talking to us, we merely have to understand what it is saying. Our technical indicators–our understanding and application of them–help us tune into the market. For any of you who have built a complex worksheet model, you understand that having to reduce something to complex to a mathematical model requires you to really understand your subject and the underlying interrelationships among the parts. An artist 'sees' what many of us do not see. Try to draw (or photograph) your cat or dog. I guarantee you that you will 'see' your subject differently. Therefore, our indicators are not predictive tools, but our venue for gaining insight. It's through the application of our tools that we 'see' what the market or our stock are doing. It is through our experience with this careful application, our missteps, mismanagement, and success that we build insight. While the tools (mechanics) are the same for everyone (just as a camera, hammer/chisel, paintbrush are the same for all artists), the results of their application will vary. In other words, it is what WE bring to those tools that determines our level of success.
I used the shaman metaphor because of its ancient tradition of knowledge and insight. A shaman is very much in tune with the world in which s/he operates and understands well the journey through the desert. That journey confers knowledge and insight (wisdom). There are no shortcuts. Ultimately we need to ensure that our own eyes are not too crossed or our talismans too many and too contradictory that we cannot see the perils in the desert. And in most traditions, to truly see, one must first look within.
We are generally the impediment to whatever we are trying to accomplish in our lives (work, relationships, school) . Selecting our tools, understanding their use and limitations, practicing our techniques (disciplines) in applying those tools and evaluating our results are the foundation of building success in whatever venue we choose (artists, surgeons, market technicians, welders, brick masons). We must remain open to possibilities that others cannot see. We must understand that our tools are what give us access to discovery. Through discovery we build insight. Through insight, we build mastery.