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The Serious philosophy Behind Technical Analysis

Feedback in:

Dear Michael, I need to contact you because I have some challenges and looking for answers/solutions. Simple question: What has been according to your own experience the most difficult part to highlight/discuss ‘technical analysis’ as a serious philosophy? I find most people (even financial professionals) rarely have an (honest) open mind to consider the awareness of their thoughts/positions in relation to crowd/group thinking. I highly appreciate your findings/reply. Keep up the good work.

Best regards,

You saw my newest 2017 edition of my book Trend Following? Your question is not exactly the question you want answered. There is a needed wider perspective.

Ep. 370: Instruments vs. Strategy with Michael Covel on Trend Following Radio

Instruments vs. Strategy with Michael Covel on Trend Following Radio
Instruments vs. Strategy with Michael Covel on Trend Following Radio

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“Should I invest in X?” is a question often heard in the investment world. Coming from the general public it is an especially strong cry out. The answer to that question is simple, although not obvious to many.

What you invest in doesn’t matter; it’s the strategy that matters. Markets are instruments: you can choose the best market and instrument for your purpose, but ultimately it is your strategy for using that market/instrument that determines the outcome.

In this commentary Michael Covel curates several excerpts from Richard Feynman to Paul Samuelson and creates a narrative to illustrate the contrast between fundamental and technical traders. Covel also makes a case study of Commodities Corporation – the hedge fund/incubator that was founded and run by some of the biggest trend following heavyweights of our time.

One of the most notable aspects of Commodities Corporation’s success is their pivot from their original fundamental strategy to a trend following strategy. Though the company is not talked about much today (bought by Goldman Sachs years back), their trend following legacy still permeates the investing world.

In this episode of Trend Following Radio:

  • Defining the exact risks involved in a trading strategy
  • The importance of liquidity: entering and exiting markets with ease
  • What we can learn from the history of Commodities Corporation
  • How the scientific method applies to trading logic
  • How Fundamental Analysis differs from Technical Analysis
  • The origins and basic principles of Trend Following Trading
  • The importance of accepting the risks and committing to your strategy

“Never mind the cheese, let me out of the trap” – Amos Hostetter

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Leave Your Analysis at the Door

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Dear Micheal, I have a question for you that you might be having an answer for it. The question is related to those that try to ignore your market views only because its not based on fundamentals but based on TA [technical analysis], which is a huge debate that has been going on for centuries. For example, when you do your analysis and come up with a result that [the] market is indicting weakness in the medium term but market continues going higher and after few weeks or a month markets start to sell off aggressively and losing 15% in 1 week. Those people come to you and tell you, “But you where bearish for a long time and market went up and if we sold at that time we would have lost that the extra profit,” while if you told them [the] market could drop tomorrow, and it did they will also say that there was not enough time to get out as your call was late. How do you over come such debate? Appreciate your thoughts. Thanks in advance.

I am a trend follower. None of this debate or analysis applies. Have you read my first two books?

Note: Asking to read my books is not a dodge to his question, but rather an answer that will make his life better if he listens.

Talking Loud and Saying Nothing

This email came in:

I am an avid listener of you podcast, I have read and seen much of your material and I have to say enjoy your controversial approach. I find it hilarious how you poke fun at the technical charting ‘fan base’, but like the many I have to say I would disagree that trend following is the only proven way. In short, I think we both agree risk management is the key to longevity whatever style you adopt, from many of the legends have been quoted that the style of trading is not the issue but finding a system which suits your personalty is critical. As 90 percent of any trade is psychological any system in the wrong hands is doomed to fail if executed emotionally even trend following. There are many famous technical traders all of which would have there profit and loss available to see from the same resources you produced when showing all the successful trend followers. I don’t think your argument towards the technicals is valid, but l do agree that trend following works and is a great trading strategy, l just think its a little naive to think its the only one. Keep up the good work, I really like your material.

Where is the data for the predictive technical analysis traders? Send me the decades of performance data. James Brown, and I say this with a smile, saw it:

The Goal Is Not How to Get an A in “How to Read a Balance Sheet”

It does not matter if you’re trading stocks or soybeans. Trading is trading, and the name of the game is to make money, not get an A in “How to Read a Balance Sheet.”

Technical analysis, the other market theory, operates in stark contrast. It is based on the belief that at any given point in time, market prices reflect all known fundamentals for that particular market. Instead of trying to evaluate fundamental factors, technical analysis looks at market prices themselves.

Predictive Technical Analysis is the Same as Fundamental Analysis

From Richard Russell:

April 5, 2011 — It’s time to clear the record and to make my current thoughts clear. Lowry’s was correct, and my PTI was correct all along. We’ve been in a primary bull market and we’re still in one. The costly and brutal decline from the 2007 high to the 2009 low was, in fact, an almost unprecedented correction in an ongoing bull market. The stock market panic-collapse was a direct result of the crash of the housing bubble. I mistakenly took the vicious decline of 2007 to 2009 as a turn in the tide and a bear market. At the March 2009 low, the (bull) market was extremely oversold. The relentless climb since the 2009 low (see chart below) was the result of a compressed bull market that was charging higher as it made up for lost time. It was like a rubber band that has been stretched too far and was snapping back to its original shape. But what of the situation now? The great bull move that started from the 2009 low is, at this point, probably near a state of exhaustion. The entire rise from the March 2009 low to the present has not yet undergone a full correction of the advance. The climb from the March 2009 low to the present added 5853 points to the Dow. The stock market now is heavily over-bought. Lowry’s Buying Power Index is off its high, and Lowry’s Selling Pressure Index is above its low. Thus, a correction should not be surprising. Considering that the Dow has gained 5853 points from its low, a one-third correction could take the Dow back to 10449. A 50% correction could take the Dow down to 9474.

Question — What should we do if the market does correct?
Answer — If the stock market corrects from the current area, I’d suggest buying the DIAs as near to the bottom of a correction as possible.

Question — Russell, why didn’t you advise buying the DIAs at or near the March 2009 decline lows?
Answer — I didn’t advise buying because I mistakenly thought the 2007 to 2009 decline was part of a major bear market. I was wrong. As it turned out, the decline was a deceptive and vicious correction within an ongoing bull market. As of now, the bull market is still in force. Therefore, any forthcoming correction should serve as a buying opportunity.

This is not trend following. I think Russell has many sage points to make, but after watching his comments for the last 2 or 3 years, enough for me. This is fundamental analysis wrapped in a so-called trend following wrapper. If I have seemed like a Russell follower over the last few years, I deserve criticism. I don’t read his stuff every day, but when this came across my desk, it was time to set the record straight.

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