ART AND SCIENCE OF TECHNICAL ANALYSIS:
First of all the science part is heavily overdone. Anybody who thinks that an algorithm guarantees his success in investing and trading will soon be disabused of the notion. Algorithms can help you cheat if you’re Lehman and their ilk and can give you an edge if you have multi-million dollar facilities for “fast trading”. And a good system will give you an edge in the markets. After all, how much brains does it take not to take 47% losses in the market? Minimal brains and a good 50 cent ruler. We have seen and used more algorithms than Carter has little liver pills. At the end of the day we believe that classical chart analysis is superior to every algorithm for the general (and often for the professional) investor.
There is some rigor to the chart analysis process. Amazingly no stock every does an Enron without breaking its trendline. And the Basing Point procedure will WITHOUT FAIL eject you from a stock or index before it goes south with Worldcom, Bear Stearns (who had lots of algorithms) and thier ilk.
Then we are confronted with the knotty problem of the present market, a real world and a theoretical problem. A rigorous analysis says that we are right on the cusp of the end of the bottom. This whole market has been so bizarre that the setting of Basing Points and horizontal trendlines is an artistic, if not a scientific nightmare. Looking at the line chart of the SPX might lead you to say the bottom is already in. Looking at the analyzed chart we see that the outer boundary of the bottom formation is 1050. The Basing Point at 991 is already taken out, giving its opinion that the bottom is over and a new up (hate to call it bull) market is in progress.
Good chart analysis finds, for a bottom, broken trendlines and the creation of horizontal trendlines. When these horizontal trendlines are decisively penetrated it’s safe to go back in the water. They are not yet decisively penetrated, but the rally has such strength that it has demanded long posiitions. These can and should be put on as the short term (monthly) downtrend lines are broken (which occurred in April and May).
These appear to be strategic questions, but in reality are tactical, as our philosophy demands a fluid and constantly adjusting portfolio, with each issue being entered on valid signals and abandoned on the violation of Basing Points. This ability to set and honor stops is what distinguishes us from the herd which held on for dear life and took disastrous losses in the bear market.
When the situation is confused and anomalous, as it is at present, it is the ability to observe this stop discipline which enables the technical investor to survive and prosper. We have often said that it is impossible to foretell the future, but reading the chart and honoring the analysis (selling Enron when it breaks its horizontal trend line) we know what to do right now.