The Great Debate

For those of you who read this blog regularly - - and there are a lot of you - - you should know that the comments section is just about as interesting as the original content. There are a lot of intelligent, insightful readers on this blog, and I personally enjoy reading what they have to say. Part of the reason for this rather lengthy entry today is some comments a few people have made.

Before I get into "The Great Debate" - that is, technical analysis versus fundamental - I want to review some very recent history (like the past 14 hours or so).

I mentioned early this morning before the market opened how the $UTIL (Dow Jones Utility Index) was vulnerable to a fall, which would mean higher interest rates. Sure enough, both MarketWatch and TheStreet declared (at the end of the day) that interest rates were the principal cause behind the market getting smacked around. (Oh, by the way, one fellow asked what security would be used to trade this market - I'd suggest symbol UTH).



In the same post, I apologized for my not-so-hot recommendations to short Hansen Natural (HANS). When I originally recommended this as a short, the stock was about $101. They posted great earnings after the close yesterday, and it opened this morning at $107, blowing out the position.

What's interesting, though, is that the stock actually ended up down for the day, as shown in the graph below. Indeed, this is a big, fat bearish engulfing pattern on gigantic volume.


So perhaps I was too hasty with my apology! But the fact is that when the stock opened at $107 this morning, that was the time to get out. There was no way to tell the stock would end up down or end up at $130. Once a stop is violated, you get out, and you get out at once. It's heartening to see I didn't screw up this analysis as badly as I feared, but I stick by my "always have a stop" rule.

I'm going to go out on a limb here (even moreso than normal) and state that I believe the bear market has finally started. This isn't a "maybe" or a "someday." This is: it's finally here. I think we finally topped out in the final week of February and the pieces are finally in place for this market to start disintegrating. MarketWatch finally got it right by declaring on its home page today:


I'll add one more thing to this assertion - the QQQQ is closer than ever to breaking below its head and shoulders pattern, as you can see below. If the QQQQ breaks below 40.16, I predict a rapid 9% decline in the NASDAQ 100. This prediction is invalidated if the QQQQ crosses above 42.01.


Now, let's turn our attention to that debate I mentioned!

As you know, I have stopped the submission of comments by Anonymous users. Because everyone - bulls and bears - are required to show themselves, my pledge is to be respectful of all opinions. As long as people aren't hiding behind the shield of anonymity, all opinions are welcome.

One bullish fellow wrote in shortly after my mea culpa post this morning with the following thoughts:

No, Trader Tim. Your mistake is not that you read the chart wrong. It is that stocks are moved by fundamentals and not technicals. All these double tops, fibonacci, trendline, and moving averages formations are pretty silly. It is the high of hubris to think that you can use chart reading to predict something as complex as the economy system. Sometimes the fundamentals and technicals happen to match so that gives you the illusion that you can use technical charting to predict the fundamentals. But it is just that, an illusion.

Let me address the core points of this comment:

• Stocks are moved by fundamentals and not technicals - I agree! Absolutely! Great earnings power stocks. No question about it. I simply believe, however, that the fundamentals are already built into the chart, as are everything else that can be known. The chart, after all, is the perfect representation of the balance between supply and demand for a given instrument. Don't you think the fundamental analysis is already built into that balance? I certainly hope you do.


• Chart patterns, Fibonacci studies, trendlines, and other studies are silly - I've been charting for many years, and experience has taught me that all of these 'silly' methods are invaluable in predicting future price movements. Different techniques work for different people - for instance, I really don't use any technical studies, but rely far more on patterns - but that's just personal preference. And I don't find Fibonacci silly; instead, I find it almost eerily predictive of the future.


• It's hubris to think you can predict the future based on technical analysis - On this point I disagree the strongest. In fact, I believe just the opposite - that fundamental analysis is the height of hubris. And that isn't just a "nyah" on my part. To my way of thinking, everything that can be known about a security is already built into a chart. Why on earth would anyone think they have some kind of special insight based on fundamentals? Don't you think all the million-buck-a-year analysts running around do a good job with this kind of thing? Do you think they actually missed something somehow? The chart has everything you need. Don't bother with fundamentals.

Another person wrote in with the following:

I too look forward to the TA fundamental dicussion, I think you should always use both. On The Hans trade I would not of entered the trade because of the major event (earnings) that was upcoming. In fact as the comments on your prior post point out it was a hard to borrow this issue in the first place I was thinking there would be a short squeeze situatuion because of this but it did not turn out to be one at least during trading hours. It looks like many holders took this as an opportunity to dispose of stock particularly in the last half hour of trading. Maybe the long time holders are happy with thier multi-thousand percent gains or they believe hans has reached its growth limits. I think the later is true and will be watching for a good short entry. I think most analysts would love to make an apology for a trade that turned out to be in the money at the end of the day.

And, finally:

The mistake was not in your technical analysis. I think that the stock was setting up as a potential double top and still is by the way, and the entry was right, to short right below overhead resistance with a tight stop over it. The problem was that the earnings were coming out this morning and usually and when one enters a trade before the day of earnings one leaves themselves vulnerable to all the upside and downside volatility that comes with the earnings report. I still think that the stock sets up the double top up here, since the break out attempt on strong earnings failed this morning and a lot of bulls included "superbull" were trapped at the top. I think it is still a short now and a much safer short than it was yesterday.

Also no analysis is bullet proof if you get 60% right you are doing great as long as you control your losses to a minimum. I use 3-5% stop loss rule. Risk management is the key to any investment.

Anyway to close on a funny note our mutual friend "superbull" who makes his decision based on strict fundamental analysis decided he wants to buy hans today. "Superbull" confident in his views that technical patterns such as double tops are silly and illusionary, he analyzed and decided to buy the stock after he saw that earnings were stellar. The company he thought was growing sales and earnings expotentially and it would go much higher than is was this morning. After all the analysts were putting buys today and they are using the same fundamental analysis he is using so he must be right. Needless to say he bought hans at $109.85 this morning. He is down $11.60 on the stock but he says it doesn't matter. His flawless analysis points out that by summer the stock will be at 500 dolars since everyone will be drinking hans drinks to cool off from the summer heat. He says he doesnt care even if the stock goes down to 50 he will average down even more down there.

So I appreciate hearing both sides. If Friday's market isn't down, I'll be very surprised.

But it all boils down to this - eventually a trend ends. Eventually even the best of stocks go from a general uptrend to a general downtrend. And it's finding that change of direction which can make you a fortune. Look no farther than BMHC, shown below. The stock seemed it could do no wrong. But it did break its trend - look where the price went to the other side of its ascending trendline - and that spelled the end of the uptrend. After bobbling up and down for a while, it had carved out a head and shoulders pattern. And now it's broken below that, which in my view spells out even more massive losses for this stock.

So I'm sure the fundmental analysis when the stock was $100 told a great story. But the trend ended, and the chart would have told you that. Buying puts on this sucker would have netted you hundreds of percent in gains. Such is the power of technical analysis.


Good luck, everyone. Keep those comments coming!