OIN SUBSCRIBER QUESTION
Some confusion over the last sentence in your 7/2 index trader article:
"The volume trend is still down, confirming the weak technical picture suggested by the fall below 37 when the trendline was pierced, making thechart picture decidedly bearish."
I thought increasing volume "confirmed" a move, in either direction, not declining volume?
I was speaking about On Balance Volume or OBV, an indicator invented to ferret out some important information from daily trading volumes. This indicator adds TOTAL volume in a plus direction on any day that the stock is up. Conversely, it deducts all daily trading volume on down days. The important thing is to look for direction.
If declining, the OBV indicator is 'confirming' a declining trend, so to speak. If advancing; if the direction of the line is overall up, this line, this On Balance Volume (OBV) Indicator, is 'confirming an up move. The direction is up or down like price.
Whereas, as you say, volume, meaning daily trading volume will tend to INCREASE in the Direction of the trend.
So volume can go UP to both 'confirm' an up or a down trend. The reverse is assumed to be true: volume will decrease in the OPPOSITE direction of the trend; e.g., tending to decrease on up days in a downtrend; tending to decrease on down days in an advancing or up trend.
MORE ON DOW THEORY AND TECHNICAL ANALYSIS.
From here, my Trader's Corner topic is a carry over from last week. This prior article can be seen online at OI website: the 6/26 Newsletter.
I said then that what came to be known as Dow Theory became applicable or became principle tenets in the art (never 'science') of technical analysis.
There was a lot more that Dow contributed to market knowledge and understanding than whether staying invested in the market was warranted or not.
What follows are the basic tenets of Charles Dow along with my thoughts on it. I should also tip my hat to the contribution of Robert Edwards and John Magee, who wrote what many consider to be the 'bible' of technical analysis, Technical Analysis of Stock Trends, for their descriptions and analogy to the "tide, wave and ripple" effect, although this did not originate with them.
THE MARKET DISCOUNTS EVERYTHING
CYCLES OF BULL AND BEAR MARKETS HAVE THE SAME REOCCURRING PHASES The point I emphasis here is that the phases of both bull and bear markets, while different depending on whether its a bull market or a bull market, are similar in terms of two factors:- elative knowledge about the market - Investor sentiment (attitude) about the market that ranges from disinterested to indifferent to interested; with varying degrees of intensity within disinterested and interested
2. A STEADY CLIMB
3. MAIN STREET ADOPTS WALL STREET
The distribution phase is also one where people who are not usually in the market become buyers of stocks. A story that I used in my book (Essential Technical Analysis) is about a friend of mine who had always only invested in real estate. This person told me near the 2000 top that he had decided to buy some stocks, but had modest expectations he only expected or wanted to make 20% on his money. This kind of expectation for stocks that historically return 10% on average and had already been going up sharply for months, was the final thing that got me out of the market.
I had noticed the froth in 2000 and that the volume was slipping and profits harder to come by. Then, my friends actions and comment became my shoe shine boy event referring to the famous story of Barnard Baruch, who one day got a stock tip from the fellow that shined his shoes. Baruch went and sold his holdings and said that when shoeshine boys are giving me stock tips, this was the time to sell. I was stuck by a similar occurrence in 2000 at Cantor Fitzgerald, where I was working in 2000, when I overheard one of our security guards on the telephone discussing his trading and going on about this and that stock in a very knowledgeable way like one of our floor traders.
The distribution phase I already knew well, having been through two earlier ones before this last one. The first was in the silver and gold bull market and bubble of the mid to late-70s. In the final phase, I finally succumb to the siren call of this market and made an impulse buy of some precious metals. At least I can re-plate my silverware with the silver bars I bought.
Then in the late summer of 86 I was the trader-manager of a stock index program at PaineWebber and had the sense to sell my positions on black Monday, but not the conviction to be short, where fortunes were made over a couple of days. (Actually the distribution phase had already completed itself by the preceding Friday and we were about to enter a panic.) The other side of my missed profit opportunity in not being short was that at least I was out - there were a lot of losses incurred, especially if investors panicked or traders had to sell to meet margin calls and didnt hang on for the ensuing weeks and months of recovery.
2. PANIC SELLING
The decline goes on longer when there is very strong conviction about the continuation of the bull market that has ended already the investing public, in general, does not believe the potential severity of the bear market or how they will eventually react to it. The handmaiden to fear, so speak, is hope. There is a reluctance to take a loss in stocks, especially a sizable one. Better to hope for a recovery. This is the phase where people will make a point of telling you that they are long-term investors. Investors have become conditioned to stocks going up and will maintain their faith in a market rebound for longer than is warranted by facts. Hope springs eternal as is said.
Selling in the discouragement phase could also be coming from those investors and traders who bought during and after the steepest declines as they thought stocks looked cheap relative the inflated values of the late bull market stage. What causes this discouraged selling is that the rallies arent sustained and prices sink lower. Theres an old analogy about the erosion of a bear market being like a faucet dripping. Such slow steady loss, over time, becomes buckets. Business conditions at this stage may deteriorate further. Certainly there is an absence of good news with corporate earnings as the economy slides further. Sound familiar?
The stocks that were very speculative, in terms of their potential to make money, may lose most of the rest of the their value in this phase. There were many Nasdaq stocks that have lost 80-90% of what they had gained in the prior bull market, in the 2 years after the March 2000 top. Blue chip type stocks tend to decline more slowly because investors hold on to them the longest.
A bear market ends when all the possible bad news has been discounted. And it after it ends there is often even more negative news that keeps coming. Keep in mind that the discounting mechanism of stocks is always also an attempt to look ahead, so stock values will reflect the expectations of what earnings could be when business conditions improve for example, about six months ahead. It also should be noted that no two bear markets are exactly alike. The 1987 bear market was amazingly short in time duration and could be measured in weeks, although the price declines were quite severe. Some bear markets skip the panic stage and others end with it as in 1987. Bear markets go on for quite different time and price durations.
Of 13 years with significant declines in the 40 years preceding the March 2000 March 2001 market drop, some have had steeper sell offs in percentage terms then what we have seen to date at least in the Dow. If we measure by the Nasdaq Composite, the 2000-2002 decline to date has brought a drop from closing weekly high to closing weekly low of 77% - 1987s loss of 37% seems minor compared to this.
The key aspect to knowing how it all works that however steep the price swings are, such as was seen in spectacular last phase of the tech bull market run up of 1998-2000 keeping in mind the characteristics of each phase will help you keep a level head. You know what is coming when the excess phase you are in ends and you can prepare for it. Keep in mind also, that these descriptions were made over 100 years ago. I have added more up to date examples, but the essential nature of the market phase stems from HUMAN nature and this is the constant or what doesnt change much. This relatively unchanged human nature, ours and others, is what you have to deal with in the stock market and it benefits us greatly when we can see which market phase we are in.
OOPS - out of time. I'll make this a 3 part-er if you can stand it. Tune in this day next week.
Good Trading Success!