Fundamentally Tech. & Caveman Technical Analysis

Da Thinkfn

"It is a basic assumption of this book that the processes of the stock market are more psychological than arithmetical. This produces the well-known tendency of stock prices as a whole to go to extremes in either direction, as optimism or pessimism holds sway."

That’s an interesting quotation. It sounds like the preface to a new treatise o­n behavioral finance, or the foreword to a book o­n technical analysis. The realization that investor optimism and pessimism are what drive prices to extremes is just now dawning o­n most of the academic community, where wearing “efficient market” blinders is a matter of faith. (They still haven’t realized that there is a 100-year old, logical, organized method of recording the battle between supply and demand that waves of optimism and pessimism produce. I’ll leave that rant for another day.)

The fascinating thing is that the quotation is from Graham and Dodd’s book, Securities Analysis, widely regarded as the bible of fundamental analysis. They are very clear o­n the fact that optimism and pessimism are the cause of stock price movement. Arithmetical measurement of value is simply the effect of the change in psychology. In other words, technical indicators measure the cause at the source; fundamental indicators measure the effect at the output end. You could say the stock market is fundamentally technical.

The other implication of stock prices going to extremes as optimism or pessimism holds sway is that it indicates there is a time to play offense and a time to play defense. Long-term investment is o­nly a good thing as long as the stock is going up. If it’s going the wrong way, it’s time to part ways. I don’t think even Ben Graham would disagree with that.

This brings us to the method we use to help determine whether a stock is controlled by demand or supply. In the end if there are more sellers than buyers willing to buy the price must decline, and if there are more buyers than sellers willing to sell, the price must decline and if buying and selling are equal then price must remain the same. There is nothing else that causes price change whether it is for produce in the market or the shoes you wear. The irrifutable law of supply and demand control all price change.

One of the beauties of point & figure analysis is that the o­nly indicator used is price. No volume, no fibonacci retracements, no waves, no guesswork of any kind. Just pure supply and demand. Often, especially by individuals new to this form of analysis, people think that by "adding" volume or another of a host of "confirming indicators" accuracy might be improved. This, I think, is a false hope. Although using o­nly price SEEMS overly simplistic, it is in fact much more robust than supposedly sophisticated models.

Here's an example. The normal correlation between the price of oil and 10-year bond yields has been 75% (Steven Wieting, Citigroup economist). That is a very high, positive correlation. Oil up, bond yields up. No doubt some sophisticated hedge fund built a predictive trading model using derivatives and leverage, making us point & figure practitioners look like we are back in the Stone Age. We may still be in the Stone Age, but the hypothetical hedge fund is belly up in a negative equity position, because the correlation since June has become inverse and is now running at -85%. The new world order is oil up, bond yields down.

How did that happen? Who knows? And, it doesn't matter. We'll leave that excuse to the economists. What IS important is that a point & figure analyst wasn't thrown off at all. Uptrends and breakouts are clearly observable in both oil and bond futures. The Stone Age point & figure charts give very accurate and direct information about supply and demand in both markets, regardless of what a finance textbook says is supposed to happen. (Come to think of it, point & figure charts bear an uncanny resemblance to certain primitive cave etchings. To survive, Cro-Magnon man certainly had to understand relative strength from a hunting standpoint: send out the hunter who has had the most success. Perhaps the extinction of Piltdown(trend) man had something to do with selecting "value" hunters: "Let's send out Ogg. He hasn't speared a boar in months!") Joking aside, the strength of point & figure is its simplicity. Supply and demand is robust. When the world changes, it changes, and can still provide accurate guidance.


Thomas J. dorsey. (, 22 Março 2005


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