In the investment world, our analysis is our map. The market can be dynamic, confusing and seemingly impossible to understand. It’s our analysis that turns chaos into harmony. In this game, the scenery is always changing. When you’re lost in the market, it’s disciplined analysis that helps you find your way.

Of course, there’s no shortage of indicators, reports and data points to consider. If you follow the fundamentals, there’s everything from revenue to price/earnings ratios. Technicians watch moving averages, relative strength, Fibonacci and other market minutiae too numerous to name.

The truth is that trading can be as complicated as you want to make it. And because of the sheer volume of statistics to consider, analysis can become paralysis real fast. But because you can’t focus on everything, you’ve got to focus on what matters, and that’s price — end of story.

I watch prices. Not the company’s breakthrough product, insider selling or the Strong Buy issued by the talking head who doesn’t own a share for himself. The price is what we trade, so the price is what I watch.

My basic premise is that the best way to determine a security’s future is to evaluate its past. So I ask, where’s XYZ trading now? Where was it last week? Last month? Last year? For me, prices are the market’s tea leaves, Ouija board and crystal ball all rolled into one.

Amateur traders watch prices too, albeit for exactly the wrong reasons. They are innately attracted to low-priced stocks, for example, lured by the prospect that a $1.25 stock will jump to $2 just a few hours after they’ve bought in. Conversely, they hate buying higher-priced stocks simply because they can’t buy a large number of shares.

Yet a stock’s price, the numerical cost per share, really doesn’t mean much. Using stock splits, a company can peg its share price just about anywhere. Without a reverse split back in 2002, for example, AT&T (T) would now be trading in the low single digits. And because Berkshire Hathaway’s (BRK.A) stock has never split, it trades at a hefty $89,000 a share. So a stock’s price in the abstract is meaningless; rather, it’s a stock’s price history that counts.

When I’m evaluating XYZ, I want to know its history better than a pair of well-worn flannel pajamas. Not just the current price, mind you, but everywhere it has traded in the past. What did XYZ look like during the bubble? The bust? How did it weather the collapse of Long Term Capital Management, the 1987 crash and other major events? By looking at price history, I try and determine when it was loved, when it was hated and when it was forgotten about altogether.

And because stocks tend to move in groups, any analysis of XYZ must include looking at similar companies within the same industry. Is the group’s price action bullish, bearish or somewhere in between? Have any similar companies blown up or recently become weak? What’s the strongest stock in the group? Is it in the sector leading the major stock indexes, or is it lagging behind?

There’s a reason it’s called “speculation.” Because no matter how much analysis we do, nobody knows what’s going to happen. While trading isn’t science, it’s not witchcraft either. For my money, if you’re going to analyze the market, then the best place to start is with the market itself.

The times in which I’m most successful are those in which I feel unequivocally knowledgeable about exactly what’s going on. The more intimately I follow prices, the more confident I am in my trades, because what’s reinforcing my market opinion isn’t an analyst or research report, but the market itself. It seems simplistic, but in an age when “research” has come to mean a positive mention by Lou Rukeyser or blurb in BusinessWeek, closely following a stock’s price history, for many investors, is a big step.

And the current market? Although I look at dozens of price charts every day, I still see little that inspires me to put new money to work. Stocks are up, but not in the consistent and orchestrated pattern upon which I believe strong trends are based. I’m not gaming the election or commenting on the war in Iraq; I’m watching prices. What I see is the choppy sort of environment in which both the longs and shorts end up churning themselves to death.

So although my eyes are wide open, my powder is still dry. When there’s money burning a hole in your pocket, the waiting is often the hardest part. I hate to be lost. So until I find a path I like, I’m resigned to stay out of the woods altogether.

– Originally on Jun 07, 2004 by Jonathan Hoenig

The problem with being overeducated is that, too often, knowing too much prompts us not to think, but rather to assume. And because a trader must always focus on a security’s current action, the challenge is often not to know your history, but to be able to forget it. From my perspective, the best indicator of the market is the market. When we know (or think) too much, we often slip into the habit of assuming relationships in the market that don’t always hold.

For instance, many people have come to assume that stocks and bonds are negatively correlated; that is, when equities rise, bonds fall. And historically, that has often been the case. But as we noted in last week’s column, over the past few months both stocks and bonds have been strong. Traders have benefited from owning not one or the other, but both.

So when it comes to analyzing two separate markets, I do my best to tune out the chatter about whether they should or shouldn’t be moving together, and instead focus on how they are moving individually. If two asset classes are strong, they merit consideration for purchase regardless of whether they seem to represent contradictory economic forecasts. You’re either an economist or a trader. Sometimes it’s thinking too much that’ll trip you up.

Another common problem unfolds when investors assume the market’s every action must be tied to a specific news event. So when stocks rally, it’s only because the SEC filed suit, or because an economic number was released or because the threat level was dropped a hue. Or when equities fall, it’s because Martha wore white, or SARS spread, or the tax cut got passed.

Get with it. The truth is that every day there’s going to be some news and every day the market is going to move. So why is it that we always try to use one to explain the other? While I do believe knowledge of current events is helpful, a trader must follow the market, not the news. That’s because the big moves — that is, the ones most worth trading — take time, and therefore can’t be pegged to a single event.

And therein lies the danger in assuming that the news moves the market. During the course of a bull run, numerous “stories” pop up that supposedly explain a market’s rise. Yet the news changes every day, while legitimate bull markets trend over time. It’s instinctive to want to know why a stock might be strong, but trading is like working for the mob: Sometimes, it’s best not to ask too many questions.

The best example can be found in the energy markets, which like many other hard assets have been in an almost uninterrupted upward trend for more than two years. But just consider, over that period of time, how many news “pegs” have been trotted out to explain the higher prices in both oil and natural gas. From the warm summer to the cold winter, from Enron to the California energy crisis, from Iraq to Iran, from the Saudis to SUVs almost everything has been mentioned except the obvious — that is, a legitimate bull move.

The best way to avoid making assumptions is to focus on what matters: price action. Because once you begin making assumptions about how an external news event might affect a market, you implicitly accept a cause-effect relationship that just doesn’t always hold up. Like Warren Buffett, a trader should stick to his or her sphere of competence. And although many professionals would seem to disagree, it’s neither economics nor journalism, but the market itself.

– Originally on Jun 09, 2003 by Jonathan Hoenig