Famed investor Jim Rogers once said 'I haven't met a rich technician,' which is a curious statement since he once worked for one of the best in the business - George Soros.
To a large degree, this is a definitional position. Many people - including Mr. Rogers - have a vague idea of technical analysis and tend to define it as simplistic pattern recognition. A head-and-shoulder top is bearish and a cup-with-handle is bullish. Such platitudes are at the heart of the conventional wisdom as to what technical analysis is all about.
More accurately, technical analysis is the general principle of respecting price action over fundamentals or other considerations. It is the recognition that the market may have some superior insight that an individual cannot develop or duplicate.
Paul Tudor Jones is a billionaire hedge fund manager that embodies how major investors employ this sort of technical analysis. It isn't as simple as bullish or bearish charts. It is the consideration of price action in different contexts as the market evolves
Unlike many technicians, Jones is a contrarian in many situations and tends to look for turning points. He respects the power of momentum but then looks for clues in it to predict market turns. In 1987 he tripled his money during the Black Monday crash.
Here are some of Jones' insights as gathered by Ivanhoff:
- "I see the younger generation hampered by the need to understand and rationalize why something should go up or down. Usually, by the time that becomes self-evident, the move is already over. When I got into the business, there as so little information on fundamentals, and what little information one could get was largely imperfect. We learned just to go with the chart. Why work when Mr. Market can do it for you?"
This is the heart of respecting price action. We will never have perfect information and there will always be someone that knows more about fundamentals than we do. However, price action is often random and misleading so our job is to sort out the movement that is meaningful from that which is predictive. We don't need to formulate complicated theories using economics. Mr. Market knows all and sees all so pay attention to him.
- "These days, there are many more deep intellectuals in the business, and that, coupled with the explosion of information on the Internet, creates the illusion that there is an explanation for everything and that the primary task is simply to find that explanation."
When a stock makes a move the first thing that most traders do is look for an explanation as to why. It is never too hard to find cause-and-effect explanations but what is worse is the inclination of pundits to believe that just because they can make a compelling argument the market is going to follow. We will want to ignore price action often but we have to be highly selective when we do so.
- "There is no training - classroom or otherwise - that can prepare for trading the last third of a move, whether it's the end of a bull market or the end of a bear market. There's typically no logic to it; irrationality reigns supreme, and no class can teach what to do during that brief, volatile reign. The only way to learn how to trade during that last, exquisite third of a move is to do it, or, more precisely, live it. Fundamentals might be good for the first third or first 50 or 60 percent of a move, but the last third of a great bull market is typically a blow-off, whereas the mania runs wild and prices go parabolic."
While Jones is very aware of the tendency for momentum to go further and last longer than seems reasonable many of his big gains come from catching turning points. He respects the price action and embraces its irrationality but stays aware that it will eventually end. During the later stages of a bull market, the folks that are quick to predict tops suffer tremendous opportunity cost. They miss out on the late-stage gains as they try to fight price action that seems irrational.
- "If I have positions going against me, I get right out; if they are going for me, I keep them... Risk control is the most important thing in trading. If you have a losing position that is making you uncomfortable, the solution is very simple: Get out, because you can always get back in... Losers average down losers."
At its heart, technical trading is using price action to impose discipline. A good technical trader doesn't allow his view of fundamentals or valuation to prevent him from cutting losses. Jones looks for price action that confirms his view of a stock and doesn't try to justify weak action by claiming the market is ignorant of reality.
The conventional wisdom is that billionaire investors are all like Warren Buffett. They focus on buying good values and then holding them for a very long time. That obviously works well if you are an extremely astute stock picker, but Paul Tudor Jones illustrates how price action can be used effectively even when managing billions. For small investors and traders without the resources of major funds, the price action is a cheap road map. Using it effectively is a challenge but all the information you need is there and if you develop the right strategies there is the potential to earn billions.