How can we judge whether fear or greed is prevailing in a stock, ETF or index? It's not something that is shown by studying company reports. Some say that fundamental analysis helps you to know what to buy and technical analysis tells you when to buy (or sell as the case may be).
Technical analysis uses price and volume alone, and assumes that everything we need to know is embodied in the chart. These charts are used to help identify patterns and trends that may give signals of possible future price movements.
"The argument is that the price behavior of individual stocks and broadly speaking of ETFs and broad market index, is that there's value in understanding price and, and, and analyzing price over time, because price should be a reflection of investor psychology, right? If all of us are optimistic about a particular company at a particular moment, we are all incentivized or all motivated to buy that demand, causing the price to go higher. So all I'm doing by analyzing price is trying to quantify that investor behavior, understanding if fear or greed is dominating. If investors are optimistic or pessimistic, if they're excited, euphoric, desperate despondent. Charts, arguably sort of illustrate that, right. It's a way of quantifying the behavior of individual investors into a broader aggregate."
"As a student pilot, I used to talk with my instructor about how we applied lessons in the air, right, what we were trying to do, flying the airplane versus what we were trying to do as investors. And there's so many similarities to it. And a lot of the techniques that, that I talk about are what I would call behavioral investing or mindful investing a what I think of as a mindful investor is paying attention to the evidence. When you're flying an airplane, you learn to trust your instruments. You learn to look around the cockpit and, and understand the information and pay attention to the information that that you're, that you're seeing there. And it's really, what's called situational awareness. It's understanding where you're at relative to your surroundings."
David is also President and Chief Strategist at Sierra Alpha Research LLC, a boutique investment research firm focused on managing risk through market awareness. He combines the strengths of technical analysis, behavioral finance, and data visualization to identify investment opportunities and enrich relationships between advisors and clients. David’s blog, Market Misbehavior, explores the intersection between behavioral psychology and the financial markets.
David was previously a Managing Director of Research for Fidelity Investments in Boston, where he managed the Technical Research Department as well as the legendary Fidelity Chart Room. He also co-managed the Business Associate Program, a rotational program for recent undergraduates.
A Past President of the Chartered Market Technician (CMT) Association, David most recently served as a Subject Matter Expert for Behavioral Finance. He is also a member of the Technical Securities Analysts Association San Francisco and the International Federation of Technical Analysts. He has lectured on technical analysis and behavioral finance as an Adjunct Professor at the Brandeis University International Business School in Waltham, Mass.
David was formerly a Technical Analysis Application Specialist with Bloomberg LP in New York and was a regular contributor to Bloomberg Markets magazine. He is editor of the book Breakthroughs in Technical Analysis: New Thinking from the World's Top Minds, published in 2007 by Bloomberg Press.
David is a classically trained musician and student pilot, and resides in Duvall, Wash. with his wife and two children. He received degrees in Music and Psychology from The Ohio State University.
TRANSCRIPT FOLLOWS AFTER THIS BRIEF MESSAGE
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Stocks for Beginners.
A lot of times for when you're thinking about technical analysis, it's not just about analyzing one particular chart, but it's, it's knowing which chart you should be looking at, right? At any given moment as an equity investor in the US, in Australia, anywhere you have literally tens of thousands of stocks that you could buy or sell at any given moment. So I think the game is not necessarily, can you analyze this chart correctly? That's a lot of times the easy part. The question is what charts should I be looking at?
Hi, and welcome back to Stocks for Beginners. I'm Phil Muscatello. Are you a visual person? How can you look at all the data available in the stock market in a way that makes sense? Today I'm speaking with David Keller on these and many other matters. Hello David.
Hey Phil, how are you?
Very good. Thank you. Thanks for coming on. David Keller CMT is chief market strategist at stockcharts.com where he helps investors minimize behavioral biases through technical analysis. He's a frequent host on stockchartsTV, and he relates mindfulness techniques to investor decision making in his blog, the mindful investor. But before we started that, I wanted to see how a classically trained musician became involved in the stock market.
1 (1m 16s):
Right? So I always tell people I have a bit of a non-traditional path into the industry, but somehow studying music really equipped me well to study the investment universe. And I'll, I'll explain why. When I was studying music, I was at the Ohio State University in, in Ohio, and I basically was focusing on orchestral conducting. So you stand in front of a group of a hundred musicians. You glanced down at a piece of music and you're trying to get them all to perform. And in some emotional state, in a similar way, you glance down at a piece of music and you immediately have to assess all sorts of things. You have to understand, you know, what, where the melody is, what the harmony is.
1 (1m 58s):
You have to understand who's leading and who's kind of following along that, you know, that theme and based on your knowledge of musical history, you have to understand or anticipate what's probably coming next, cuz it's all about, you know, how that style is set to be performed. And when I learned that there was a toolkit called technical analysis that would basically allow you to analyze investor behavior using charts in visualizations. The first time I saw a price chart, it felt like I was looking at an orchestral score somehow. And I, I, I somehow I felt that it, I, I, I had training as a conductor to actually study the market. So I, it, it, it was a transition that was way more easy than I thought.
1 (2m 38s):
And obviously there's a big musical or a big mathematical component in music as well. And with finance, with investing there certainly is of course as well.
2 (2m 46s):
Yeah. I can really relate to that. I mean, I'm from a sound engineering background originally. And for me, when I'm looking at charts, what I'm thinking about is a mixing console in front of me and how that kind of relates. I, I, I can really understand how that those wheels kind of turn in your head when you're looking at price charts.
1 (3m 3s):
That's exactly right. And, and, and I think that the thinking about market history as another one, I mean, a lot of what I do I feel like is, is serving as a market historian, what tends to happen in the summer months in the us. Why does may through October tend to be seasonally weak? Why does the market tend to bottom in a certain time of the year, you know, with where we're at right now, what's happened when interest rates have gone up when inflation is, is a concern when the fed has been very accommodative and then changes. And, and a lot of that is by looking at market history and actually seeing what the market has done in different bull and bear cycles. So that, that sort of market historian hat combined with analyzing the information has served me pretty well.
1 (3m 44s):
I feel like,
2 (3m 44s):
So is there a Baroque period of market action?
1 (3m 51s):
Now? That's a great question. I, you probably could. That's a, that's a book that I will write Phil and, and I will give you credit for that idea up front different market periods related to musical periods. There may be something there.
2 (4m 2s):
So just a little bit about your background and history, you worked at what was known as the legendary Fidelity Chart Room, what made it legendary?
1 (4m 10s):
2 (4m 11s):
Is there a plaque, is there a plaque on the door or anything?
1 (4m 14s):
There, there is a lot of great history in that space and, and fidelity. You know, the, the technical research team is one of the largest in the world. I had, I had 13 analysts that worked for me when I was, when I was there 2008 to 2016 and technical analysis was very much part of the culture of fidelity. And so the money managers, you know, really appreciated the value of fundamental analysis and quantitative analysis and very importantly, technical analysis and, and having an awareness of market sentiment and investor psychology. So the chart room was literally a physical repository of market history. It was a, it was a space dedicated to data visualization to understanding and appreciating the lessons of market history and, and taking a step back from what I would call the flickering ticks of the market, the short termism that we often get drawn into and really respecting the longer term trends.
1 (5m 5s):
And so I was able to go through there with a lot of really successful investors, fidelity money managers, and, and many others. And when you think about the decisions that had been made with that, as the, as the setting for that, it was humbling and really, really fun to, to use that space, to try to make better decisions.
2 (5m 22s):
The market has many forces acting upon it and fund managers, for example, their imperative is to make quarterly returns as opposed to what long term investors are looking at, or other kinds of investors is that the, that kind of short term noise is not part of what they are looking at in the, in investing. I dunno where this question was going, but I'll throw that thought to you.
1 (5m 48s):
Yeah, I think there's a, there's a challenge. I, I think for a lot of investors and particularly for money managers and, and companies, right? I mean, you're, if you're managing a, a, a big, big conglomerate, you know, there's a lot of pressure to have a quarterly earnings number that looks pretty good. And, you know, the quarterly discussion, the quarterly earnings call is a big thing. Same with money manager. You have a quarterly call with, you know, with investors or with key shareholders. And there's a lot of, a lot of those discussions that I sat in on. We're trying to relate what we saw in the short term with the bigger picture and understanding more of the three year five year, 10 year trajectory, which is where a lot of the shareholders, a lot of individual investors are really trying to perform, oh, that's the timeframe that they're working on.
1 (6m 29s):
And I think that's one of the challenges with the financial industry. There's so much that is drawn to the short-term market movements, particularly financial media. There's such an urgency to every little data point because that makes it engaging and exciting in reality investing if done well, should be boring. A lot of the times I I've often told people, I think one of the biggest, you know, mistakes is that words like investing and trading imply taking some sort of action, right? I trade means I actually push, buy or sell in reality. Investing should be a lot of thinking and strategizing and relating things and, and, and structuring an investment process and less on actually buying and selling. I, I think a lot of times doing nothing is probably the best option for investors.
2 (7m 13s):
So let's talk about technical analysis and the data visualization aspects of it. No, sorry. Everyone's just waking up, including the cat and the dog who are chasing each other answering, and you might see my wife making her coffee in the background, we ground the beans before we started. Okay. Back to the question. Yeah. So let's talk about data visualization and technical analysis. And of course being a stock market podcast, I'm always talking with guests who are bringing up Charlie Munger and Warren buffet and the fundamental kind of people. So can you just give us a little brief overview of what technical analysis is as opposed to fundamental analysis?
1 (7m 55s):
Absolutely. So, you know, if you think about what, you're, what you're looking at when you're looking at a company fundamentally, right, you're looking at the earnings, you're looking at the potential growth in earnings. You're looking at financial statements, you're looking at quarterly data to understand how the company is doing and, and thinking about the ability of the management team to grow earnings or to, you know, grow the business over time and how they're gonna be able to do that. What technical analysis does is it doesn't look at the company. It looks at the stock. The argument is that the price behavior of individual stocks and broadly speaking of ETFs and broad market index, is that there's value in understanding price and, and, and analyzing price over time, because price should be a reflection of investor psychology, right?
1 (8m 39s):
If all of us are optimistic about a particular company at a particular moment, we are all incentivized or all motivated to buy that demand, causes the price to go higher. So all I'm doing by analyzing price is trying to quantify that investor behavior, understanding if fear or greed is dominating. If investors are optimistic or pessimistic, if they're excited, euphoric, desperate despondent. Charts, arguably sort of illustrate that, right. It's a way of quantifying the behavior of individual investors into a broader aggregate that actually changes the value of stocks and ETFs. So some of the early, and, and really the practitioners that promoted and, and popularized technical analysis, people like John Murphy and Martin Pring, and they're even predecessors before that, like Gan and Elliot and Jesse Livermore, you know, they, and, and before that Charles Dow who's really, you know, considered the grandfather of technical analysis.
1 (9m 32s):
You know, they basically promoted this concept that you can analyze price. And by doing that make inferences or, or draw conclusions about the overall strength or weakness of a particular asset.
2 (9m 43s):
And, and I commend listeners read Jesse Livermore. I mean, it's very old, very old book, but to hear how the stock market used to run in those bucket shops, it's insane.
1 (9m 54s):
Yeah. Asset, I mean, in some ways dramatically different from today in, in many ways, though, very, very similar, right? If you think of the cycles of fear and greed that he talks about on those books, you're still seeing it in a very computerized format in 2022, but a lot of those lessons still hold up. I think
2 (10m 11s):
Many people, when they think of technical analysis, they they've got the charts with, they've got the candle sticks, and then there's all these lines moving all over it. And people drawing lines from here and there. And I think a lot of people think, well, you know, you could just draw those lines anywhere, but let's just talk about a couple of the simplest lines, which are moving averages. Can you describe what moving averages
1 (10m 32s):
Are? Yes. And I appreciate your question, Phil, the phrasing of your question. There's a lot of wisdom in there. I think a lot of excuse, particularly newer investors try to overcomplicate things. They try to put a lot of data, a lot of information. And if you look at the charts and, and, and think about the, the charts that you know, that, that myself or others that use, they're very straightforward, right? It's more about understanding trend. And if you overcomplicate, it's actually very hard to, to, to quantify trends very well. Moving averages are one of the classic parts of the technical toolkit. And, and the reality is day to day movements in assets, in any asset equities, commodities, currencies, cryptocurrencies are very noisy, right?
1 (11m 13s):
The day to day, minute to minute movement of any, any market is gonna be noisy because there are all these buyers and sellers coming together at random times in different places. And as a result, things fluctuate dramatically. What technical analysis really tries to help you do is step away from that noise and think about how the trends are evolving. So if you're looking at a daily closing price of inequity or of an ETF, you are getting the change or the, the daily movements, the moving averages sort of take that trend over a longer period of time. So a 50 day moving average is literally an average of the last 50 closing prices. And that average moves along every trading day. And that's why it's called a, a moving average. If you ignore the day to day price, and just look at the 50 day, moving average, you will be able to tell whether the trend is positive or negative based on whether that moving average is sloping high or lower is the average trend increasing or decreasing.
1 (12m 4s):
And in general, owning stocks in ETFs where the prices above their moving average versus below will immediately have you in things that have been performing well. And out of things that are underperforming, a lot of times that basic kind of assessment can help. I think a lot of individual investors make sure that you're in things that are showing strength and leaning away from things that are showing weakness, moving averages are a great way to make that basic assessment.
2 (12m 27s):
Another technical analyst I've had on the program talks about looking at a chart from across the room, and you should be able to, the trend should be clear enough that you can see it from 10 feet away.
1 (12m 39s):
I love that. One of the, one of the technical analysts I used to follow that sadly is no longer with us. He was elderly. He was in his seventies. When I, when I last met him, he came to visit us in Boston and he took off his glasses and he said, I like trends that I don't need my glasses to see that's, that's a, that's a great, you know, similar reaction. And I think that's absolutely right. I always coach my viewers, take a step back away from your monitor. What, what happens? I think for a lot of people, if you just look physically ergonomics aside, when you're looking at a chart, you immediately start leaning into the monitor, right? You're almost drawing in and getting what you're doing is getting closer and closer to the noise. I always tell people, take a step back and just really think about how this thing has, has moved over time.
1 (13m 19s):
Instead of looking at, you know, six months, look at six years and really look at how trends are evolving. That's how you really understand how things are changing and how markets are rotating, which I think for a lot of investors is the game. It's the rotation in and out of different themes in different charts.
2 (13m 40s):
What would you recommend for a listener coming and opening up a chart for the first time and okay. They, they put in a code and then they're presented with all this data on this screen. How would you recommend them starting to work out a way of looking at it? So it's a bit more meaningful
1 (13m 57s):
Once you bring up, once you bring up the chart, you're, you're absolutely right. I think a, a lot of times, what I would encourage people to do is start with price, right? The analysis of price is really where it starts. And I always tell people, start with where we're at now and look to the left. Where are we at relative to where we've been? And a lot of technical analysis is driven off of that understanding of where we're at now, relative to where we've been. Are we in a position of strength? Are we in a position of weakness? Are we trending higher or lower? And Charles Dow, you know, over a hundred years ago, late 19th century was talking about the value of looking at trends and measuring them going higher by looking at highs and lows are, are the, are the high prices trending higher? Are the low prices trending lower and making that basic assessment will make sure that you're in things that are working and that you're not in things that are not working.
1 (14m 45s):
I know at stock charts, we have a whole section of our website called chart school, which is trying to help newer investors that are less familiar with the technical toolkit, really appreciate and understand where it starts and it starts with price. And then there are all sorts of different things you can do to better quantify investor behavior, measuring trend characteristics, measuring momentum, how strong a price is moving, looking at a particular stock relative to other stocks, which is called relative strength. There are all sorts of other tools you can bring to bear to better align your technical analysis with the questions you're trying to answer as an investor, but it starts with an analysis of, of price and really thinking about simple measurements of trend. And that's where I encourage people to start.
2 (15m 24s):
And what about the going back to moving averages? That idea? I know one of the simplest indicators is the, is it the 20 day over the 50 day moving average and that, that they cross, am I correct in saying that?
1 (15m 36s):
Yeah. So there are a number of different moving average techniques and you're, you're talking about a really simple one it's called the moving average crossover technique, right? Looking at different moving averages. And when they cross above or below one, another longer term, investors tend to look at things like the 50 day and the 200 day, which is looking more of a, you know, about a quarter and about a year, a little less than that, but that's kind of what it was trying to do. Shorter term investors, the five versus the 20 day, the 20 day versus the 50 day and those combinations and which ones are right for you, depend on what timeframe, what, what are your investment horizon is right? So if you're a position trader or a swing trader or a long term investor in a retirement account, your charts that you use in terms of the types of moving averages, even the timeframes, am I looking at hourly data versus weekly or monthly data should all be aligned with the, with the timeframe that you're trying to invest on.
1 (16m 25s):
So question number one should be for you. What am I trying to do? What are my goals with my portfolio? And then make sure the charts, the techniques that you're using are in line with those goals. A lot of times there's a mismatch, and then you can be making incorrect decisions, cuz you're basing it off of the wrong timeframe.
2 (16m 38s):
Really? What are the mindfulness techniques that you ESP?
1 (16m 42s):
Thanks so much for asking that. And a lot of the, the techniques that I use and have used over time in my work at stock charts and my own firm called Sierra alpha research, it's all based on what I've learned, flying airplanes. It's all based on aviation. As a student pilot, I used to talk with my instructor about how we applied lessons in the air, right, what we were trying to do, flying the airplane versus what we were trying to do as investors. And there's so many similarities to it. And a lot of the techniques that, that I talk about are what I would call behavioral investing or mindful investing a what I think of as a mindful investor is paying attention to the evidence. When you're flying an airplane, you learn to trust your instruments.
1 (17m 24s):
You learn to look around the cockpit and, and understand the information and pay attention to the information that that you're, that you're seeing there. And it's really, what's called situational awareness. It's understanding where you're at relative to your surroundings. I find a lot of times investors kind of put the blinders on. They have a particular position or a particular stock or ETF that they're focused on and they forget to take a step back and look at what's happening around them as investors, a mindfulness for me means having an awareness centering yourself mentally, but also having a good awareness of what's happening around you. And that's where I feel like charts technical analysis can be really, really helpful. If there's a toolkit that's designed really optimized to help you understand the world around you.
1 (18m 5s):
I think charts are a really good way to do that. So I think mindful investors pay attention to their surroundings as investors. A lot of times for when you're thinking about technical analysis, it's not just about analyzing one particular chart, but it's, it's knowing which chart you should be looking at. Right? And any given moment as an equity investor in the us, in Australia, anywhere you have literally tens of thousands of stocks that you could buy or sell in any given moment. So I think the game is not necessarily, can you analyze this chart correctly? That's a lot of times the easy part, the question is what charts should I be looking at? So there's a whole set of screening tools that you can use. And I think charts are a really good way. Technical analysis is a great way of trying to look on an apple apples basis among thousands of charts to try to figure out where are the actionable ideas.
1 (18m 53s):
So if you, if you think about particular conditions, you know, I'm looking for stocks that are breaking to new highs, I'm looking for stocks that have been beaten down and are now starting to show signs of accumulation using the best practices of technical analysis. You can, you know, very simply code that sort of behavior into a scan. And then, alright, let me find a bunch of stocks that have been beaten down and are, are starting to improve charts that have been out of favor and are now in favor. And I think by applying those techniques consistently, and that's the real key, it's having a consistent routine, you can find good opportunities for me. One of the things I often scan for are stocks making new three month highs and stocks making new three month lows. I look at that list multiple times every week, and it helps me to really understand the changing dynamics of a market environment.
2 (19m 39s):
And, and of course, if you're looking for those lows, you're in danger of catching a falling knife. So you are actually, I'm assuming looking for other indicators. I think you mentioned accumulation to show that you just don't wanna catch it.
1 (19m 51s):
I would. Yeah, that's exactly right. I was, I was taught that prices go down for a reason. So if you, if you're looking for something and the price keeps going down, you have to remember that a stock doesn't just go from 50 to 40 to 30 to 20 for no reason, right? There's a reason why the price is going lower. So I often look for what I call signs of accumulation rate, bottoming pattern, right? You know, very simply a, a down trend is a pattern of lower lows and lower highs. So when that trend is in place, when the stock keeps making lower lows and then when it bounces higher, it doesn't eclipse the previous high, that's a chart in a down trend. Look for that to change, look for a stock, making a higher low look for a stock, making a higher high in the us right now, the chart of apple comes to mind as a great illustration of that in a clear down trend in the first half of 2022, starting in June, it stopped making a lower, low and started making a higher, low.
1 (20m 41s):
It made a, a lower high in June and all of a sudden has made a higher high now July into August. So recognizing those trend changes a lot of times is the most important, most important question. I think investors should be trying to answer
2 (20m 54s):
And kind of implicit in what you were saying there as well. And something I firmly believe is that the price of a stock doesn't care about your feelings.
1 (21m 5s):
That is, that is very, very well said, Phil, Phil, and I would say a hundred percent. That's true. You know, and, and, and, and it's funny, it, it is so easy for us to react in a very emotional, very visceral, very physical way when something moves against us, right? When you make a trade and it stops working, and the price is moving against you and you're losing money on paper, it is very normal and understandable to have a physical, you know, your, your Palm starts sweating and you get uncomfortable with it. I think what successful investors do just like successful pilots is learn to separate their emotional reaction from their actual right, their, the, the action that they take and make decisions based on the weight of the evidence and less on the weight of your emotions.
1 (21m 48s):
If you can do that, I think you've done a great job. You're winning the game emotionally and, and, and mentally, if you can separate your emotional reaction from the evidence that you're seeing,
2 (21m 57s):
And what are your thoughts on candle sticks? There's a lot of people who put a lot of thought and meaning into what candle sticks will mean. You know, there's different shapes and, you know, there's hammers and
1 (22m 7s):
Very much so. Yeah, candlestick are a whole set of techniques. And it's really, I mean, in a lot of ways, it's a different way of, you know, normal in the, in the west. We often look at price bars, right? Bar charts, which is a bar representing the open high, low enclosed candlestick are just a different way of visualizing that it's a much more visual form of analysis, right? Because up days,
2 (22m 28s):
Perhaps before we go on, you should explain what a candlestick actually is.
1 (22m 31s):
Sure. So, so a bar chart, you basically have a vertical line, which tells you the high and the low trade for every day or whatever timeframe you're looking at. Candle charts. Tell you, tell you the same thing. I have a vertical line, which tells you the high and low, the body of the candle is what's different. So on a bar chart, you have a tick to the left, which is the opening price and a tick to the right, which is the closing price. So it's easy to see one individual day, but it's actually a little harder when you look at a large amount of data to visually recognize updates and down days, cuz it all just kind of gets jumbled together. Candle charts, the body of the candle tells you the open and the close and up day is a clear candle or an open candle. And I always tell people think of it like a, a balloon that's filled with helium.
1 (23m 11s):
So it's floating up. So you opened at the bottom of the candle and you closed at the top of the candle, a solid candle or a darker candle is something that closed down on the day. So think of it as like a rock sinking down into a pool. So you opened at the top of the candle and closed at the bottom of the candle. It is a Japanese form of analysis. And if you talk to Japanese technical analysts or investors, and I've, I've been fortunate to travel to Japan a number of times and talk with real expert practitioners in candlestick analysis. And they will tell you that it is really a visual form of analysis. You look at how the market has changed based on the configuration, the shapes of the candles, jump out. Now you alluded to some of the names, there are some very exotic names when you get to candlestick analysis, things like abandoned baby and doji candles and three white Knight and three black crows.
1 (23m 56s):
And I always tell people, focus less on the exotic name and nomenclature and focus on what they're telling you about the intraday dynamics. What we saw this week, actually in the us are a lot of dodgy candles and a lot of what are called shooting star candles, doji candles, when the open and close are right about at the same level and it represents indecision, right? We open at a certain point. We trade around there, but we close right at the same level. So we, we didn't go anywhere. So it represents that in investors of sort of at an equilibrium, a shooting star handles when you open, you trade higher, but you close back at the lows and think about what that means when the stock is going higher, but then this one day you open higher. But instead of closing higher, you actually close back at the lows of the day and it represents some distribution forces going on during the trade day.
1 (24m 40s):
So I actually do use candlesticks a lot when I'm trying to understand the short term dynamics behind a particular chart. And I think it's a very fantastic visual way of representing trader psychology and supply and demand in the short
2 (24m 52s):
Term. And it's quite an ancient technique, isn't it it's been around for hundreds of years in rice farming trading in Japan, which, which is where it came from.
1 (25m 1s):
Yes. So there are actually a whole, the, the whole history of technical analysis in Japan, very different than what we've seen in the, in the us, our modern technical analysis was really born in the late 18 hundreds, early 19 hundreds in Japan. It goes back to the 16 hundreds if I remember, right. And we have evidence of, of rice traders back at that time using a, a simplistic form of candlestick analysis to actually understand the movements in the, in the rice markets. And it's fascinating how those same techniques still in 2022 are a beautiful visualization of supply and demand. And I think, you know, the lessons like that, you mentioned Jesse Livermore earlier. I think one of the great things about technical analysis, it is a form of analysis that predates quantitative analysis certainly predates fundamental analysis and was a way for individual investors to get an edge and understand what was happening.
1 (25m 51s):
And I think that still holds water here in the, in the 2000 twenties.
2 (25m 55s):
Well, we'll put some links in the blog post for this episode as well to some of your videos and so forth, which listeners can go more in depth then. But I had a, a list of points here that I wanted to talk about because they just seemed just the, the title seemed interesting. What is the endowment effect?
1 (26m 13s):
Yes. Well, a whole separate part of what I do is, is what's called behavioral finance, which are basically categorizing investor behavior.
2 (26m 20s):
Yeah. Which we're kind of jumping in between technical and, and behavior.
1 (26m 23s):
Yeah, that's right. But I, but I, I would argue that technical analysis and charts are a great way of managing a lot of these behavioral biases. What the endowment bias that you mentioned, what it basically is, is you have an emotional attachment to something that you own. So in the investment world, we talk about a stock, right? You take a position and now you're emotionally connected to that position. So let's say the position starts losing money, right? You're losing that in that position, but you feel an emotional attachment as a result. You're more likely to hold onto it longer than you should. Not because the evidence tells you, you should, but because it have emotional connection to that, to that position, I think charts, and you mentioned things like moving averages, things like price, trend, candlestick analysis, all those things should be doing is telling you when the evidence changes when a position that has been working is no longer working.
1 (27m 8s):
And what that should do is help you disconnect from that emotional bias that, that endowment bias and, and recognize when the evidence has shifted and, and, and be bold enough and courageous enough to take action, despite your emotional attachment to a particular theme, a particular thesis or a particular position,
2 (27m 26s):
Classical technical analysis, always refers to different patterns, appearing on the chart like, you know, heads and shoulders and pennants and things like that. Is that what you are taking into account as well?
1 (27m 39s):
Absolutely. So the, the technical toolkit is broad and there and diverse, and, and there are a lot of different techniques under there. I think growing as a technical analyst over the last 22 years, you sort of develop your own toolkit. You find things that you tend to gravitate toward. I would say certain price patterns. We absolutely keep a attention to. You mentioned the head and shoulders pattern, which to be honest with you was one of the first patterns where there was academic research. It was in the 1980s. I feel like there's a, a paper by Carol Osler talking about the head and shoulders pattern in the currency markets and how is a great actual predictor of what was coming next and all that does head and shoulders patterns and others. What they do is they recognize the trend, not just one individual there or one individual moment, but how the trends actually evolve over time.
1 (28m 26s):
And what a head and shoulders top really is, is a market's going higher and higher. And all of a sudden you put in a lower high. So instead of making new highs, all of a sudden buyers are exhausted a little bit. There's less buying power and less potential for the market to go higher and breaking down from that pattern is often a great illustration that there's a change of character in that the trend is starting to go lower. It's something, if you flip that over, it's called the head and shoulders bottoming pattern. I think for a lot of us based investors, that's where you're looking opportunistically in the us markets. Are you finding head and shoulders, bottoming pattern in some of the growth areas of the market, like technology, consumer discretionary, which had really been deteriorating through the course of 2022, but now June, July, August started to show rotation to the upside.
2 (29m 10s):
Okay. Jumping back to behavioral now. Yes. The narrative effect. What is that?
1 (29m 13s):
Yeah. So the, the narrative effect is a, is a brilliant one. And if you think about it, I always like to share the example of buying a car. Most of us have bought a car at some point in our lives. And what happens right? When you go to a car dealer, they don't start just telling you details about the vehicle. Here's the size of the engine. Here's your fuel efficiency. What they want to do is get you behind the wheel. They want you to test drive because the moment you get behind the wheel, you are connected to the idea of the car. It's no longer the price tag. It's no longer the implications of, of the fuel efficiency or the performance of the vehicle. You're picturing yourself in the car and they are building a narrative for you. You're no longer buying a physical piece of machinery. You're buying the idea of you owning the car, and that's what they want to get you to that narrative as investors, we do the same thing.
1 (29m 58s):
We create this narrative interest rates are going higher, which means that probably means the fed is doing this. And that most likely means XYZ for this bank that I'm looking at or these commodities or the dollar or the OSCE dollar, whatever it is that you're interested in. And the that's a good thing. If it helps you think about different scenarios, the problem is the narrative effect is we tend to get way too tied to that narrative. All of a sudden, when the evidence starts to change, we're still so emotionally connected to that narrative. It's hard for us to disconnect. So what I often suggest to people to minimize this bias is to thinking about different scenarios. If you're bullish on stocks right now, list out the bear case, literally get a piece of paper and lay what would cause this market to be more bearish, right?
1 (30m 42s):
What would I need to see on key stocks on currencies, on ETFs that would tell me the, the position or, or the, the conditions are changing. And in my days of fidelity, we would literally do this. We'd have a bull bear meeting where some of the analysts would have to argue the bull case on a particular chart. The other group would have to argue the bear case. And we did that simply to force ourselves to think about different scenarios. Institutional investors never think of certainties. You always think about probabilities. Here's what I think is most likely to happen, but here are the other three things that I think could happen. And you think about all those potential paths and what your portfolio would do in those scenarios and what action you should take now to minimize the risk of what, you know, if one of those other scenarios happened, I find individual investors get way caught up in a narrative.
1 (31m 26s):
You think of one absolute thing, and that's it, make sure you stretch yourself and think about some alternative scenarios.
2 (31m 33s):
It's this is interesting. I was talking to a fund manager just a couple of days ago. They look at a distribution curve of possible outcomes. And I know that's not strictly technical analysis, but it speaks to what you are talking about and how professional money managers are looking ahead and saying, well, okay, the, the price could go up here, but you know, it could also go down here as well. And then again, because they've got a whole team of people, they're all arguing with each other and looking at scenarios, and that's what you really need for your investing thesis is to have argument and people challenging your ideas.
1 (32m 6s):
I, I, I, I think you're absolutely right. And, and I, I would say my experience as an institutional investor, it was not quiet. It was noisy. There was a lot of debate and discuss, and that was a, that was a common practice was jump into someone else's office and just debate something you think Gold's going up or down and why. And we would challenge each other's thesis. And any times you would present an investment thesis to a group, you would expect aggressive pushback at times, pushing back on your assumptions. And I find for individual investors, there's not enough of that. To the contrary. I would say the rise in social media has made it way worse on the other side, social media, particularly if you use Twitter or Facebook or Instagram, whatever it is as an investor, the moment that you like things or that you, you know, tell the algorithm that you like a certain point of view, all it does, it becomes an echo chamber, and they try to give you more and more of that thing.
1 (32m 56s):
So if I look at my Twitter feed right now, after years of liking growth, oriented technical investors, it's an echo chamber for my own thesis. Right? And so what you have to do is actually search for the opposite. So if I'm bullish on stocks, I search for bearish arguments to try to see what people are seeing and thinking that causes them to draw another conclusions. So social media is great in terms of the access that you get to some very successful investors and, and many that you may not have ever heard of before without social media. But I would say the detriment of social media to an individual investor is that a lot of times it'll be an echo chamber for something you already think. And you really wanna look for things that challenge your thesis, look for alternate points of view they're out there, but you have to do a little work to find them
2 (33m 39s):
All right, Dave. So I'm gonna put all the links in the episode notes and in the blog post as well, but just give us a quick overview about how listeners can find out more about you and about stock charts.
1 (33m 49s):
Yeah. It's such a pleasure to, to chat with you, Phil, and thanks so much for the, for the opportunity. Stock charts.com is our, our main website. And we offer free trials to people that aren't familiar with the service. I would encourage people to start with the free part of our site, which is called chart school. You have a lot of free charts that you can use, of course, but chart school really teaches you how to make better decisions. And I would encourage you to do that. We're also on YouTube and my, I host a closing bell show called the final bar. If you go to the stock charts, YouTube channel, you can see all of my previous episodes going back for, for a number of years.
2 (34m 20s):
And of course, we'll put all those in the episode notes and blog posts, as I said, Dave Keller, thank you very much for coming and joining me today.
1 (34m 27s):
It is a pleasure Phil, and thank you for what you're doing to empower newer investors and individual investors to make better decisions. I, I hope they are listening to the wisdom that you're sharing with them.
2 (34m 37s):
You're giving me undue respect, Dave. Thank you, mate. See ya.
1 (34m 43s):
It's a pleasure.
2 (34m 44s):
If you found this podcast helpful, please tell a friend, especially if it's someone who needs to start thinking about investing for their future, you'll be helping them and helping me to keep this show on the road.
0 (34m 55s):
Stocks for beginners is for information and educational purposes, only it isn't financial advice and you shouldn't buy or sell any investments based on what you've heard here. Any opinion or commentary is the view of the speaker only not stocks for beginners. This podcast doesn't replace professional advice regarding your personal financial needs circumstances or current situation.
2 (35m 13s):
And thank you for listening to my podcast.
Stocks for Beginners is for information and educational purposes only. It isn’t financial advice, and you shouldn’t buy or sell any investments based on what you’ve heard here. Any opinion or commentary is the view of the speaker only not Stocks for Beginners. This podcast doesn’t replace professional advice regarding your personal financial needs, circumstances or current situation.