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Technical Analysis, I



-- Posted Monday, 20 April 2009 | | Source: GoldSeek.com

By Howard S. Katz

 

Today I want to have a little discussion of the technical methods I use at the One-handed Economist.  Methods of predicting the markets divide into two kinds: technical and fundamental.  Early in my career the fundamentalists convinced me that the vast majority of them could not predict the markets.  They would argue, in 1966, that you should buy “good, sound stocks for the long pull.”  (Gee, they were making that same argument in 2007.)  From 1966 to 1982, the value of the DJI, adjusted for the depreciation of the currency, fell by over 70%.  This convinced me that at least the vast majority of fundamentalists did not know what they were talking about.

 

          Now fundamental analysis can sometimes work.  The classic case of good fundamental analysis is that of Mayer (the British) Rothschild at the battle of Waterloo.  Nobody knew who was going to win (and in retrospect it was a near run thing).  But if the British lost, then it meant a long war, which would have to be financed by paper money.  So a defeat at Waterloo would have sent the British gilt (long bond) crashing.  Rothschild sent his agents across the Channel with a team of homing pigeons (the hi-tech form of communications of that day).  When Napoleon was defeated, the agents released the pigeons, and they carried the news to Rothschild.  However, Rothschild was known and feared on the British gilt market.  As soon as he walked on the floor of the exchange and started to buy, the word would have spread, “Rothschild is buying.  He must know something.”  So he walked onto the floor and started to sell.  The word spread, “Rothschild is selling,” and a wave of selling hit the gilt market.  Meanwhile, a number of Rothschild agents were on the floor buying everything that was for sale.  Rothschild loaded up, and when the official news of the battle was reported, he made a nice chunk of money.

 

          This example gives you an idea of the limitations of fundamental analysis.  You have to have fundamental information which is unknown to the rest of the market.  And you very likely have to have the resources of a Rothschild to get that information.  How many people would have bet, on June 15, 1815, that Napoleon could be defeated?  But that was the fundamental information which counted.  (Besides, if that happened today, they probably would have put Rothschild in jail for insider trading.)

 

          Technical analysis, on the other hand, looks at the data available from the market itself.  What has the price been?  What was the volume?  What are the derivative markets doing?  I still believe that the best work on technical analysis is the book, Technical Analysis of Stock Trends by Edwards and Magee.  This book presents certain patterns which form in the stock (or commodity) price and which have predictive value.

 

 

          A good example of a chart pattern which might have appeared in Edwards and Magee (had their book been written today) is the saucer or rounding bottom in gold which stretched from Oct. 1997 to Dec. 2002.  This was a massive 4 year chart pattern, which predicted the rise in gold which we have had thus far in the 21st century.  Further, it remains in effect and could carry a significant distance further.

 

          First, the above is a bar (or western) chart.  It includes the high, low and closing prices for each period.  In this case, I have chosen to make a monthly basis chart; so each bar represents the high and low for a given month with the cross hatch representing the close.  Bar charts usually plot volume (on the bottom of the chart), but since the popularity of candlestick charts (which do not include volume), it is often omitted.

 

          Notice how the chart has a rounding appearance, slowly coming to a bottom and then rising – hence the name rounding bottom or saucer.  An important characteristic of a valid saucer bottom is a sharp rally off the bottom (contrasting dramatically with the earlier dullness).  In gold, this rally occurred in Sept.-Oct. 1999.  This rally defines the high-low range of the formation.

 

          The economic good then retreats from the sharp spike and makes a test of the low.  It resumes its earlier dullness.  Notice that at this time (April 2001) the gold mines were shorting their own product.  What a commentary this is on fundamental analysis.  Who but the world’s largest gold mines should know the fundamentals of gold better than anyone else?  Yet they were selling their own product short right at the bottom.  They suffered for this for many years and were finally driven to cover their shorts at much higher prices.  If they don’t know the fundamentals, then what are your chances?

 

          The astonishing thing about this is that in every American industry the people who work in the industry are perennial bulls on their own product.  If you make aluminum, you are a bull on aluminum.  If you are in computers, you are a bull on computers.  If you produce food, you are a bull on food.  And yet propaganda from the gold-hating establishment rubbed off on the gold mines themselves, and they lost a lot of money shorting their own product just when they should have been buying.

 

          The saucer finally gave a buy signal in December 2002, when it broke above its spike high of 337.5 (again on volume).  This was Edwards and Magee saying to us: TIME TO BUY GOLD.  And this is when I turned bullish on the metal.

 

          Notice that chart patterns do not signal you to buy at the exact bottom; neither do they signal you to sell at the exact top.  However, the Jan. 21, 1980 gold top was a great sell signal.  It ran up from 812 to 875 (the interday high) and then fell back to close at 825 – all on heavy volume.  This is a pattern called the one-day reversal, and although I did not catch the exact top, I knew by the end of the day that gold had made an important top.  This was the end of the great bull move of the 1970s.

 

          However, buying at the exact bottom and selling at the exact top is too high a standard.  Only one or two people can do this, usually by luck.  And it is not necessary.  All that is necessary for you to make money is to sell higher than you buy.  And to this end, chart patterns are a big aid.

 

          You have probably heard charts speak of support and resistance levels.  They throw around numbers (which usually don’t seem to work out).  What are these people talking about?  Okay, let us take a good example, again from the gold market.

 

 

 

          Notice how, in March 2008, gold made an important high which stands out on the chart.  Not only does it stand out on the chart, it stands out in people’s minds.  A brokerage house is likely to run a sheet on the good and include two numbers: recent high and recent low.  For gold these might be 1040 and 680.  The implication to customers is that, if the good is near its recent high, that is as high as it can go and it is probably a sell.  On the other hand, if the good is near its recent low, that is as low as it can go, and it is probably a buy.  Many people think this way, and therefore a lot of selling will come in as gold approaches its old high.  We say that gold is at a resistance level.  If gold came down to 680, conversely we would say that it was at a support level.

 

          I have discovered what is going on in people’s minds in this regard.  The great philosopher St. Thomas Aquinas argued that every good had a fair price, which is the price it should trade at.  This was widely believed in the Middle Ages.  Adam Smith refuted this idea when he wrote Wealth of Nations, but most people in the world today are not educated to Adam Smith and still cling to their medieval ideas.

 

          But when you are trading the markets, which is the fair price?  St. Thomas did not give us a way to figure that out.  So believers in this idea simply take the price which stands out in their minds and treat it as fair.  Since the gold price of $1040 was a relative high, they will assume that this is as high as gold will go, and they will use this price as a sell.  It was this consideration which led me to recommend a sell on gold on Feb. 20 when it reached the $1000 level.

 

          What is the next move for gold?  I am watching the markets and will let you know in my newsletter, The One-handed Economist ($300 per year), as soon as the markets give their signal.  To get a subscription, you must visit my website, www.thegoldbug.net.  There is no charge for a visit, but you risk being offended by my opinions on political and social issues.  This week’s blog is about the right to health care.  It is guaranteed to offend 50% of the readers.  I am the kind of guy who doesn’t care how many people he offends but cares a great deal about whether he is right or wrong.  If this appeals to you, then maybe you are my kind of man.

 

# # #


-- Posted Monday, 20 April 2009 | Digg This Article | Source: GoldSeek.com




 



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