My View on Technical Trading and 3C

The Problem With Fundamental Analysis

Fundamental Analysis seeks to identify value through assessment of everything about a company that can't be found on a chart and doesn't have to do with what happens on the floor of an exchange or over the NASDAQ network. The problem is, do you trust that the information that you use is correct? Think Enron, this was no boiler-room operation. Do you think the information is timely enough to provide you an edge? Can you analyze the information and uncover something that multitudes of multi-million dollar research departments are searching for? Are you a PhD in economics and accounting? Do you have the benefit of playing golf with the company's CEO or having lunch with the CFO or having your son-in-law working in the accounting department? In short, do you really believe that you can create an edge over Wall Street, because an edge is what you need to make money?

The Problem With Technical Analysis

The concept behind Technical Analysis could probably be summed up as, “follow in the footprints of those who know”. “We”, the little guys are not “those in the know”. We are those out of the know, those who don't know so we look for clues based on supply and demand, price, volume, patterns, basically anything that derives from price and volume we use to uncover the hidden footprints of “those who know”.

Why are the footprints hidden? It's simple really, take a look at Hovnanian Enterprises A (HOV) around 2000. The Tech Bubble, like all bubbles was the one that “was different this time”. When markets decline or even crash or run through the notorious “Business Cycle”, money seems to evaporate or disappear, nothing could be further from the truth. Money, now like then and like all bubbles and crashes before, is simply displaced from the hands of the many to the hands of the few. Did you know the Federal Reserve is a for-profit corporation with share-holders and all that jazz that seeks to make money (not just physically) for it's shareholders just like ANY OTHER BANK?

Between April 1998 and March 2000, HOV lost nearly 50% of it's share value as investors poured their money into Tech. As the Tech mess was in the early stages of a Bear market in mid March 2000, money was flowing from the Tech sector into others. Specifically some far-sighted investors saw the potential of the Home Builders and understood the mechanics of what was underway and likely to occur with interest rates and a recovery and QUIETLY money flowed into companies like HOV. This didn't cause the typical Bull market run that people normally associate with accumulation or “the BIG Boys” investing in a sector, instead HOV remained relatively constrained trading most of the year 2000 between $5.30 and $6.50 with the average price being about $6.00. Make no mistake, accumulation was underway. As practitioners of Technical Analysis, this is ideally the situation we are trying to uncover, the hidden gem, the footprints in the sand which have been carefully covered over. And why?





Wouldn't the “Big Boys” want us to jump in with them and drive up price? Yes, but at the time and place of their choosing. First they need to accumulate a position and when you are investing hundreds of millions of dollars, you need to be quiet about it or you will drive up prices and cause your average price paid to be far in excess of $6.00. After they've accumulated their position and after the amount of shares available has diminished to the point in which demand is causing price to rise, a breakout will eventually occur. This is typically the point in which most technicians will pickup the blip on the radar screen (around Aug 2000-some well into 2001), after a large move in volume and share price has occurred. Some will catch it earlier after accumulation but before the breakout when the diminished supply is causing price patterns to show signs of accumulation (June/July 2000).

At this point we have a breakout, we have gone from a Stage 1 Base or accumulation to a Stage 2 Breakout or more appropriately known as “Mark-up”. Many technicians believe this is when the “Big-Boys” are pouring money into the stock. While this is true to an extent, the reality is this spectacular price advance is all over the news, it's causing a buying frenzy and an abundance of demand, which is exactly what these “Big-Boys” need to start selling their shares, not buying. This demand allows them to sell at a good price. If they put their abundance of shares into a market with thin demand they would cause prices to sink, but in Mark-up, the demand allows them to get a better price. So where do you as a technician want to buy, when the “Big Boys” are buying or selling?

And the problem with Technical Analysis? Go look at 10 software platforms and make a list of their standard set of indicators. Go thumb through 10 Technical Analysis books and make a list of their trading indicators. I bet you'll find that many of them are repetitive. For example: Moving averages, MACD, Relative Strength, Stochastics, etc. Here is the problem, everyone is looking at the same thing. Everyone is using the same moving averages, looking for support at the 50 day or the 200 day, or looking for pennants or triangles or bull-flags. Technical Analysis used to have a stigma attached to it, it was VooDoo and it probably worked a bit better then, but since the advent of the computer and the internet, Technical Analysis has exploded and it's hard not to find a trader who doesn't use it. This in itself becomes a weakness that the “Big-Boys” and Market Makers, and shrewd traders all take advantage of.

If there has been a clear consolidation in a stock that forms a clear triangle and the breakout point is under, say a whole number like $10 (this is a psychological magnet for stops “I'll place my buy at the breakout at $10”), then this situation presents a very lucrative and tempting offer to a market maker that is paid on the spread. If there's a huge supply of buy orders accumulated at $10 because everyone is looking at this triangle and the breakout point being near such an obvious mental trigger, then the market maker is almost obligated to push prices through the $10 level just to trigger those buy orders, even if there's no real demand, especially if there's no real demand and he'd know. The market maker would trigger the orders, fill them, in effect sell short and the lack of real demand would cause prices to fall back down causing a false breakout. The buyers are now at a loss and begin to sell to exit their losing position. Their selling causes an imbalance which pushes prices lower and allows the market maker to cover his short at lower prices and make more money, along with any shrewd shorts who may have joined in on the trade.



This is but one example of how everyone looking at the same set of tools has become a disadvantage and a liability. You need to get out there and think for yourself. This is why I created my own set of indicators which I share with people trying to make money in this tough environment. 3C is one of those indicators. Look at the chart of HOV (above) in 2000 with a 3C daily indicator in blue. Note that each test of the low, the first in December, the second in March and the third in June, made a higher low in the indicator which is a sign of accumulation. If you look back to July of 1999, you can even see the signs of distribution (selling) as price made a higher high and the indicator made a lower high. This is my way of looking at the market with a different eye, maybe it helps you or inspires you to create something that works better for you. I say Wall Street is a flock of Sheep, be the Wolf!

For more information on 3C and my Charting Software, click email me and click on this link.