But think about it: If someone really had an airtight, foolproof method of consistently making money in the market, why on earth would they share it with you for a mere $39 a month?

That being said, I do think technical analysis is inherently superior to more traditional investing methods. Technical analysis is focused on analyzing the market itself rather than other fundamental factors we assume will influence the market. And because markets are generally not chaotic, but rather tend to move in trends, I believe the best indicator of XYZ is often XYZ itself.

It wasn’t too long ago when technical analysis was dismissed as pure voodoo. That’s changed in recent years. Not only has the advent of computer technology allowed price charting to become far quicker and more cost effective, but the limitations of traditional fundamental analysis have been evidenced during both the late 1990s boom and the early 2000s bust.

The truth is that strict fundamental analysis would have likely kept you out of stocks for most of the 1990s bull market, when traditional methods of valuation were, for all intents and purposes, worthless. Stocks were expensive, but they stayed expensive for more than five years of historical gains. And while the bull market eventually turned into a bubble that burst, a heck of a lot of money was made along the way.

Many practitioners of fundamental analysis were also burned on the way down. Even as stocks declined, investors who held on because financial results were improving were often right but sorry. Because even as many company’s financial results improved, their valuations shrank. For example, Amazon.com (AMZN) reported its first net profit in January 2002. By that time, however, the stock had already dropped from more than $105 to less than $15.

And that’s the real rub: Fundamental analysis might lead you to excellent companies with sound balance sheets — but when it comes to actually making money, that often isn’t enough. As we’ve pointed out over the years, there’s a big difference between a company and its stock price. The idea is to sell stocks at higher prices than we’ve paid for them. And although economists and analysts always seem to suggest otherwise, it’s not a sales report or income statement we trade, but a piece of paper whose value is ultimately based solely on supply and demand. This is the crux of why I prefer technical analysis. It focuses on what’s important: the stock price. Everything else is window dressing.

Of course, technical analysis is no holy grail. No single methodology or tool — from fundamental analysis of quarterly cash flow to technical analysis using Bollinger bands — works every time. The markets are far too efficient for that to happen. The key to trading isn’t a fancy gimmick, but discipline.

And that’s where technical analysis really excels. As we often like to point out, it’s not what you trade, but how you trade that makes the biggest difference to your bottom line. When used correctly, technical analysis provides sound trading ideas as well as a disciplined framework for deploying capital and limiting risk, because it provides what fundamental analysis lacks: a trading strategy for getting into — and, perhaps more important, out of — a particular stock.

While I don’t claim to be an expert on technical analysis, or even knowledgeable as to all of its many indicators, I’ve found it exceedingly helpful in developing disciplined, rules-based trading plans. Again, no system is perfect, but if you follow the rules, you tend to stay away from the big blow-ups that can quickly knock a trader out of the game.

Consider the moving average; one of the most commonly used technical indicators. This measure simply illustrates the average value of a security’s price over a predetermined period of time. The commonly cited 200-day moving average, for instance, is calculated by adding the last 200 closing prices for a particular security and then dividing by 200.

As the investment moves, so does the average price. Because it factors a security’s historical price, moving averages tend to smooth out the short-term volatility and provide a better idea of a security’s overall trend. The most common way of using moving averages is to buy the security when the price crosses above the moving average, or sell it when it crosses below.

Is using a 200-day moving average the secret formula for stock market riches? Hardly. I don’t believe technical analysis provides any “magic number” that generates only winning trades. What it does provide, however, is what most people need: a plan. Because if you buy XYZ as it moves above the 200-day moving average, you’ve got to sell it (for a loss) should it cross meaningfully below the same average. That’s what I think works so well about technical analysis: If an indicator gets you in the market, it should be able to get you out of the market as well.

I think some people follow technical signals too feverishly. I don’t need to buy the first tick above the 200-day moving average in order to use it, nor do I need to get stopped out at the absolute first price below the average. But when I’m long (and wrong) and XYZ crosses below the indicator I happen to be following, I know it’s time to get out, and in fairly short order. One common approach is to use the moving average as a guide for setting stop-loss orders. So if you buy XYZ as it crosses above its moving average, you’d set (and maintain) your stop at 5% or 10% below the average.

When it comes to trading discipline, however, the discipline is often much harder than the trading. And what happens to many people is that as their indicators fail, they don’t abandon the trade, but simply find new indicators to justify not selling at a loss. When discipline fails, so does technical analysis.

– Originally on Aug 11, 2003 by Jonathan Hoenig

Most of us understand that old saw to be about style — about winning or losing with equal aplomb and sportsmanship. But to a trader, it’s a lesson in technique. It reminds us that whether you win or lose is a function of how you play the game.

I can’t say it often enough: It isn’t what you trade, but how you trade, that ultimately determines success. And nowhere can this be seen better than in the case of energy giant Enron (ENE), whose spectacular 99% decline has left more than a few investors out in the cold.

Most pundits would suggest that Enron’s woes first became apparent in mid-October, when the company took a $1 billion charge and reduced its shareholders’ equity by $1.2 billion as a result of a number of questionable off-balance-sheet partnerships. But from a trader’s perspective, the problems for Enron and its investors actually started much earlier. While Enron’s collapse was stunning, good trading technique could’ve limited the damage to investors’ bottom line.

Many are now blaming the company for their losses, but regardless of any alleged corporate wrongdoing, following a trading discipline would’ve prevented a position in Enron from hurting your portfolio too badly. That’s the essence of investing. You win a few, you lose a few, you keep on fighting.

So let’s say that you bought Enron, and at the high. Not just a high, but the high of $90.75, reached on Aug. 23, 2000.

And if you listened to the analysts, you had good reason. Just two days earlier, both Banc of America and DLJ upped their already aggressive price targets, with DLJ expecting the stock to hit $115. Even pundit Elaine Garzarelli called it one of her top picks. Just over a month before the stock hit its all-time high, Salomon Smith Barney picked Enron as No. 6 on its list of “TEN+ Exceptional Names,” a portfolio of 15 stocks the firm considered to be among the most compelling buys.

The media got into the Enron-adoration act, too. Fortune named the company No. 7 on its widely watched list of 500 top companies. The magazine didn’t have much choice in the matter, since the Fortune 500 are chosen and ranked by revenues. But four months later, it went on to highlight Enron in a special feature piece entitled, “10 Stocks to Last the Decade.” As it turned out, of course, Enron didn’t last the next 16 months.

The issue isn’t that they — and you, if you bought when they told you to — were wrong. It’s whether you were wrong big or wrong small. Probably the most important component of trading technique we’ve discussed is that of position size. It isn’t what you bet on, but how big you bet. More than any variable, the size of our trades ultimately determines their net effect.

Excessive position size was tragic for so many Enron workers, whose retirement plans were dominated by company stock. But they didn’t have any choice. Many pros did, however — and they also bought too much. The 37% year-to-date decline in the AIM Global Infrastructure fund (GIFAX) wasn’t just due to a position in Enron, but to the fact that Enron was the fund’s largest holding. It’s one thing to be bullish, but putting more than 5% or 10% of your portfolio into a single name at a single price is just asking for trouble, no matter how bright the fundamentals look.

Even more damaging is buying more. As we’ve pointed out in the past, losses are just part of the game. So even if you were completely wrong in your timing and bought the stock at $90, you wouldn’t have been hurt too badly providing you didn’t continue to add to that losing position.

But most people don’t want to be profitable. They want to be right. So it wasn’t just that they bought the stock at $90, but — egged on by the analysts — that they also doubled up at $80, tripled down at $70, and so on. The best traders aren’t those who are always right, but those who are able to admit when they’re wrong.

And the truth is that Enron gave investors plenty of opportunity to make that admission, as its stock chart shows. After all, it isn’t as if this stock got halved in one day. It was in steady decline the entire year, but you had to be watching. Although the dire news didn’t come out until October, the aware trader listening to the market would’ve known something was wrong long before Enron hit the single digits (and the front page of The Wall Street Journal). Even looking for the most basic trend indicator — lower lows — you can see how Enron broke significant support in March, in May, in July, August and right up until now. When a stock just keeps moving lower, even on light volume, it’s telling you something: “Don’t buy me.”

But because the news was still relatively positive, you had to be watching the stock — not listening to the supposed experts. As early as late January, even after the stock had corrected some 20%, Prudential upped its earnings-per-share estimate. Morningstar was bullish, too, suggesting that Enron deserved its high price. In February, with the stock down over 30% for the year, UBS Warburg analyst Ron Barone, like many others, still liked the stock. He called it a Strong Buy with a $102 price target, a move that would’ve taken a 78% gain. By October, with the shares at $33 (down 60% for the year), Merrill Lynch upgraded the stock from a Long-Term Accumulate to a Long-Term Buy. And as recently as a few weeks ago, Salomon Smith Barney was reiterating a Strong Buy, with Enron down an exceptional 70% since the firm put it on its list of “Exceptional Names.”

In both the markets and our lives, the answers are usually there if you’re simply willing to listen. While the news didn’t get bleak for Enron until October, the chart had been worrisome the entire year. And even if you knew nothing about the company’s fundamentals, you would’ve known that the stock was weak, which was reason enough to avoid it or reduce a position.

We’ve often heard about how birds chirp warnings just before a surprise summer rain, or how dogs start howling before an earthquake. Maybe you have to be as silly as a bird or as dumb as a dog to understand the evidence that’s staring you right in the face, because it’s something that seems beyond most financial journalists, analysts and other smart humans.

– Originally on Dec 10, 2001 by Jonathan Hoenig

The philosophy is based on the view that nearly all stocks experience four price stages: accumulation (stage 1), uptrending (stage 2), top area (stage 3), and downtrending (stage 4). Therefore, an investor, has a high probability of success if he or she enters the cycle just before the stock moves to stage 2. Then he explains how to select a stock by simply studying its price/volume chart and how to time your entry.

He addresses the issue of fundamental vs technical analysis. He explains that technical analysis is much superior over fundamental analysis because technical analysis incorporates future information that is not available to the average investor on a timely basis. I found the book very clear and very helpful in selecting winning stocks with less stress. I read several books but this one is the best of them all.

The book discusses when to buy, how to refine the buying process, when to sell, selling short, recognizing market tops and bottoms all in a manner so clear that you won’t have to read a sentence twice for the sake of understanding alone. The quizes at the end of each chapter are meant to reinforce your understanding and I think it is a great idea.

It is for longer term trading, perhaps 3 months or more, depending on how long the stock trends upward. This is probably the best longer term trading method I have seen.I wouldn’t say Weinstein’s methods are “secrets,” they are just 100% common sense, and very effective.

If you’re a beginner or intermediate, this book will certainly give you a huge boost in mastering chart reading as well as execution. Unlike any books that sort of short in explaining one critical area, I find Stan’s book very clear and entertaining as well. It opens your eyes on what to look for in a chart.

It is one of my favorite trading/investing books.

The main topics in this book include: Preservation of capital, consistent profitability, technical analysis and trading rules. He tells how to spot a trend and discusses technical analysis. How to spot the tops and bottoms in any market. There is also a lot of detail about economics and what makes the system tick, which as he says he didn’t learn in school. Moving averages, booms and busts, and how to manage risk and have a good business philosophy for consistant success are also part of this well written book of trader knowledge. He covers a great deal of useful information in a very compact form that is actually easy to read and understand.

His methods are a mixture of fundamental and technical analysis. He uses economics as a forecasting tool and says that cycle analysis actually just gets in the way. If you can understand the fundamentals of economics you can interpret government intervention in the market and profit from it. University taught economics is useless for this. All booms and busts are a result of credit expansion in an effort to lower interest rates, whereas Keynesian economics attempts to use interventionalist policy to smooth out the peaks and troughs but in fact is the predominant cause. Surplus production, savings and innovation create wealth as much for the individual as the economy on the whole. Wealth is actually consumed by government created prosperity via deficit spending. You can’t get something for nothing. By understanding these cycles, you can speculate profitably.

Technical tools can then be used for timing entry. He demonstrates how trendlines can be drawn objectively to determine a change in trend using his 123 and 2B rules. A unique approach in this book is an approach to measuring risk by calculating market life expectancy profiles which he says has been instrumental to his success along with his business philosophy of protecting capital, consistent profitability and the pursuit of superior gains.

This book is as much a confession of the soul as a guide on trading methods, which I’ve found most of the best trading books are. He clarified a number of issues in my own mind and extended my thinking in critical areas.

But all the Web’s information overload encourages most investors to focus on the wrong question — whether to buy, sell or hold a stock. Now, you wouldn’t think this would be such a complicated problem. After all, pick a stock and you’ve got at least even odds that it will appreciate. In fact, you’ve got better than even odds, since the market has historically demonstrated an upward bias. So then why do so many people lose money buying individual stocks, and lose even more money trading them?

The answer is because trading is a matter of technique, not simple prognostication. What has been missing from this seemingly endless (and often mind-numbing dialog) about the market’s next move is frank discussion about the craft of trading.

Most traders and commentators focus on security selection and analysis. There are millions of investors who’ve been sold on the idea that making money is simply the process of buying “solid, quality companies” and holding onto them for long periods of time. We would like to think that good companies have good stocks, but in reality it’s very difficult to demonstrate a direct cause-and-effect relationship between a company’s fundamentals and its stock price. No matter how much research we do, the future is by definition, unknowable. The stocks are just going to move as they damn well please.

And that’s why the question most traders should focus on isn’t what to buy, but how to buy. It doesn’t matter if you’re trading soybeans or Cisco (CSCO); cultivating a sound technique will have a bigger impact on your bottom line than any stock pick ever could.

Unfortunately, most people want easy answers. They want a stock tip. If your trading technique is limited to asking a friend “what do you think of XYZ?” I suggest you buy a mutual fund and leave trading to those with the patience to learn how it’s done. But if you’re interested in learning how to trade, that’s what you’ll get in the coming months from this column.

I begin with cultivating a philosophy that the process of investment is about making money and protecting one’s purchasing power against inflation. While that seems almost too obvious to mention, the fact is that many people are drawn to the financial markets for exactly the wrong reason. They want action. They want quick money.

In my experience, those who crave the adrenaline high of a gambling fix would be better served by a trip to the blackjack tables rather than the stock tables. If you must bid on something, hit eBay, not E*trade.

I want to make money. I don’t need to buy every bottom or sell every top, nor does my ego need boosting from friends or cheerleaders on financial television. I’m not looking for an adrenaline rush or something to talk about at cocktail parties. The point of this whole exercise is to make money. Everything else is just conversation.

As a trader, I approach all markets with egalitarian indifference. I have no allegiance to any particular asset class or trading style. My faith isn’t in stocks, but the bottom line.

I won’t say that fundamental analysis is completely useless — just darn close. Attempts to justify why a company should trade at 125 times earnings rather than 80 times border on the insane. And if you buy a stock that trades at a mere 80 times earnings (like say, Cisco Systems), don’t kid yourself that you’re buying a piece of the company’s business — i.e., of its fundamentals — since it will take decades before your portion of earnings exceeds what you paid for it. The fundamentals are pretty unlikely to justify your purchase of a stock whose price-to-earnings ratio dwarfs your investment time horizon. All you’re really doing is waiting for a greater fool to come along.

So forget the fundamentals and spare me the message-board banter. Let’s talk technique and start by understanding what really moves markets — and that is the relationship between price and liquidity.

More than any other factor, what moves XYZ higher is the liquidity situation for the company’s shares. Got it? What moves the market — any market — is a disruption in the normal supply-and-demand situation for that particular security. Stocks go up because there is more demand than supply at current prices. End of story.

So I primarily use technical analysis — not because technical analysis is a guarantee of profit, but because nothing is more central to my goal of making money than the price action of a particular security. If you’re going to attempt to profit from buying low and selling high, studying the price action itself seems like a logical place to start. I’ve got better things to do with my time than figure out how many Pampers Wal-Mart (WMT) is going to sell in the fourth quarter. Technical analysis is where the rubber meets the road. In short, a stock is good if I’m long and it’s moving higher.

So if the fundamentals are out, what should you watch? What criteria would prompt you to buy a particular security? And once you’ve decided to buy, when is a good time to get in? And how do you practice sound money-management skills that can protect your downside while participating in the upside? I’ll approach these nuts and bolts of making the trade in my next column, one week from today.

– Originally on Feb 08, 2001 by Jonathan Hoenig