The Finance Book Club

Chapter 21 - Contrarian or Conformist?
“It is impossible to produce a superior performance unless you do something different from the majority.” - Sir John Templeton

 

1. According to Montier the consensus portfolio is small cap, low quality so he advises large cap, high quality
2. ‘The central principle of investment is to go contrary to the general opinion, on the grounds that if everyone agreed about its merit, the investment is inevitably too dear and therefore unattractive.’ - Keynes
3. Dasgupta et al. found that, on average, the stocks that fund managers had bought most over the last five quarters underperformed the stocks they had sold most, by 17%
4. Montier mentions that 'almost everyone is bullish' which makes him nervous. Good call in 2007.
5. Investors Intelligence survey shows nearly 60% bullish (a good contrarian indicator)
6. "Buying large, old, low-risk, highly profitable, dividend payers [is] generally a good idea when optimism [is] exceedingly high"
7. “To buy when others are despondently selling and to sell when others are greedily buying requires the greatest fortitude and pays the greatest rewards” - Templeton
8. The consensus view is in the price
9. "Even the perennially bearish Richard Bernstein of Merrill Lynch appears to have turned bullish!" (This is often one of the best contrarian indicators, a long-bearish pundit finally capitulating)
10. Montier recommends being overweight cash
11. Attached Image (click to enlarge)

    
    
    Value over growth

Chapter 22 - Painting by Numbers: An Ode to Quant

1. Simple quantitative models consistently outperform humans.
2. There is nothing machines won't do better than people eventually...
   Attached Image (click to enlarge)

   
   
   except maybe love...and hate.
3. Why aren't there more quant funds?
   1. Montier gives the usual reasons, hubris, biases, and inertia
   2. However he maybe just had to wait a decade because now quant firms are everywhere.

   
   
   

4. Unlike humans, the more info we give a quant model, the better it performs.
5. Even when humans were given the quant models to use as inputs they underperformed robots.
   1. Poor weak fleshlings.

   
   
   

6. Quant models are increasingly accepted by finance
   1. But it's curious to me that they haven't completely dominated the industry

   
   
   

7. Montier predicts that quants will remain on the fringe
   1. but I think he's already been proven wrong?

   
   
   

Chapter 23 - The Perfect Value Investor

1. Behavioural characteristics of the world's best value managers:
   1. Undying adherence to their deeply-held value principles - in other words the path set down by Ben Graham
      1. There's that name again!

   2. Concentrated portfolios - average 35 stocks with a couple of international value funds, where the average US mutual fund has ~160 stocks
   3. Specialists - not obsessed with knowing everything about everything (uh-oh!)
      1. Ignore noise
      2. No legions of analysts generating forecasts
      3. Risk is the outlook for profit margins and balance sheets not price volatility

   4. Willingness to hold cash in the face of uncertainty and lack of opportunities
      1. Average cash holding is 11%, nearly 3x greater than avg. mutual fund

   5. Long time horizons.
      1. Avg holding period of 5 years compared to just one year for the avg. mutual fund

   6. Acceptance of bad years
      1. Undperperformance 30-40% of the time
      2. "I would rather lose half my shareholders than half my shareholders money"

   7. Will close their funds to new money
      1. Efficient frontier of funds is finite so past a certain point there is a drawback to taking on more money
      2. Fiduciary responsibility

Chapter 24 - A Blast from the Past

"Regular readers of Global Equity Strategy will be acutely aware that I’m interested in the works of two legendary investors – John Maynard Keynes and Ben Graham."
Oh really? I hadn't noticed.

1. Both Keynes and Graham thought it was important to distinguish between investment and speculation
2. Shared a faith in value investing
3. Recognized the dangers of excessive volatility
4. Both had complicated love lives!
   1. Montier doesn't elaborate but Wikipedia tells us that Keynes was a man-whore, with multiple lovers. Am I allowed to say this? Risky!
   2. Graham married thrice, including marrying his son's former wife after the former committed suicide in France. His wife rejected his offer of polyamory.

   
   

5. Losses mainly come from purchasing 'low-quality' securities during favourable business conditions
6. When sentiment sours on an overbought market it will fall precipitously
7. Almost everything worth saying about investment has been written before
   1. However most of Keynes/Graham's advice has been 'unheeded'

   
   

8. Extolled patient, value-based stock selection over illusory growth stories at shrinking time horizon

I can't summarize all the quotes but Montier does group them in the following categories:

1. The importance of separating speculation and investment
2. The danger of excessive volatility
3. The difficulty of remaining true to one's principles in the face of short-termism and underperformance
4. The folly of forecasting
5. The role of governance and agency problems (investors should not forget that company officers are only loyal to the owners)
6. The importance of dividends paid regularly or at increasing rates
7. The importance and pain of being contrarian
8. Pro investor flaws (mostly ignoring overvaluations and buying at any price in a frenzy)
9. The limits of arbitrage
10. The importance of a long-term horizon
11. The difficulty of defining value
12. The need to understand price relative to value (value is a function of price)
13. Behavioural biases don't cancel out
14. Diversification (too much is bad; large positions in stocks we don't understand is also bad.)
15. The importance of a margin of safety
16. The dangers of overcomplicating
17. The importance of knowing history

Obviously there is a lot to gain by reading these authors on their own.

Chapter 25 - Why Not Value? The Behavioural Stumbling Blocks

1. It is fact that value outperforms over the long term
2. Despite this, there are few 'true' value managers
3. What stops people from doing what's right?
4. Once again, biases
5. Knowledge != behaviour
   1. Not everyone who knows about AIDS decides to use condoms
   2. knowing that value outperforms isn't enough to persuade everyone

   
   

6. Everyone is chasing a strategy that doesn't lose money (guilty)
7. Long time horizons are not natural to humans
   1. Instant gratification just feels good

   
   

8. Going against the crowd is painful and neuroscience shows that we feel it in the brain the same way we feel physical pain
   1. FOMO, anyone?

   
   

9. The stories associated with value stocks will generally be poor (Montier doesn't say why except to say there will be a variety of reasons)
   1. Resisting these stories and focusing on whether the price reflects these stories is difficult

   
   

10. Overconfidence, as usual
11. We massively discount future behaviour over current intentions
    1. I'm going to go to bed early and get up and exercise tomorrow!
    2. Tomorrow: Oh noes!

    
    

Chapter 26 - Bargain Hunter (or It Offers Me Protection)

This is about the half-way point of the book. Most of the chapters that follow are not exclusively the work of Montier but are co-written with various authors.

 

1. Theoretically growth is a good investment
2. The problem is identifying growth is difficult (and presumably more difficult than identifying value)
3. Value investing admits we are limited and offers protection against mistakes while outperforming
4. Growth investing typically is just momentum-following of expensive stocks

Really seems like we are repeating ourselves now. A common problem with books.

Chapter 27 - Better Value (or The Dean Was Right!)

1. Graham-Dodd's 'Security Analysis' (the Bible for Montier)
   1. Urges investors to use a cyclically adjusted PE to avoid being whipsawed by the economic cycle
   2. If investors simply extrapolate from the past then they will be too optimistic during boomtimes and too pessimistic during downturns
   3. "A straightforward strategy of buying low one year trailing earnings PE and selling high PE stocks applied to the MSCI World Index generated a return of 11% p.a. over our sample period of 1980–2005 (with a one-year holding period and annual rebalancing). However, we found that extending the time horizon for the calculation of earnings could improve performance significantly."
   4. "By the time we extend the time horizon all the way out to Graham and Dodd’s maximum suggested 10-year moving average, the gap between low PE and high PE stocks is an average 25% p.a.!"
   5. "Graham and Dodd suggested cyclically adjusting PEs way back in 1934, and yet investors still obsess and insist on trying to forecast the cycle as the best way of adding value!"

2. G-D PEs
   1. These are PEs (price/earnings) based on current prices divided by the 10-year moving average of 'as reported' earnings. (quotes mine)
   2. The purpose of a long average is to abstract from the business cycle
   3. "Even a mere lack of interest or enthusiasm may impel a price decline to absurdly low levels" - Graham
   4. Forecasts of future growth - no good, as we have established
   5. Graham had never seen “dependable calculations made about common-stock values. . . that went beyond simple arithmetic or the most elementary algebra”.
   6. Attached Image (click to enlarge)

      
      
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Chapter 28 - The Little Note that Beats the Markets

This chapter is in praise of Joel Greenblatt's "Little Book That Beats The Market". Montier notes that it is only 155 pages, which is 615 fewer than 'Security Analysis' by Graham-Dodd and 471 pages shorter than Graham's "Intelligent Investor". Maybe we should seek it out. You might remember Greenblatt as being one of the traders interviewed by Jack Schwager.

The Little Book Method:

1. Rank the instrument universe by return on capital and by earnings yield
2. Buy the 30 stocks with the best combined score
3. "Good companies at bargain prices"
4. Montier says Greenblatt's strategy works in all markets with impressive results, beating the market by 4-11% in the various regions.
5. EBIT/EV is a better measure of value than simple earnings yield
6. EBIT/EV works even better than Greenblatt's original strategy
7. However during 'bubble' years this strategy underperforms, so a fund manager using it would likely get fired
8. Following quant models like this one is 'relatively boring' - it involves taking no meetings and requires patience
9. "Investing is simple but not easy." - Buffett

EY + ROC = The Little Book strategy
EY = EBIT/EV
ROC = Return on capital as defined above
PE + ROA = simple trailing earnings yield plus return on assets
PE = simple trailing earnings yield
ROA = return on assets
Well, this is something else we could dig into. What do you think?

Chapter 29 - Improving Returns Using Inside Information
This isn’t the kind of insider information that will have you sharing a cell with Bernard Madoff.

1. Look at what companies do, not what they say.
2. You can improve your odds by buying shares when insiders are buying and selling when they raise equity.
3. Companies raise equity when it’s cheap for them, which is expensive for you
4. The statistic is called ‘net equity issuance’
5. Montier sings the praises of a paper by Bali, et al (2006)
   1. They drastically improve the returns on a simple strategy of buying the cheapest 20% of stocks by P/B by selecting from those with negative net equity issuance (repurchasers)
   2. This works for both value and growth stocks, but naturally, more so for value
   3. It gets better though because we can improve the returns even more by going long value repurchasers (VP) and shorting growth net issuers (GI)
   4. This VP-GI strategy reached 47% in 4 years
   5. For Montier this also puts a nail in the coffin of the EMH, the results are exactly what behavioural investing would predict

Chapter 30 - Just a Little Patience 1

This is a recap of what we already know, that investors are becoming more like speculators and that trading time horizons have shrunk drastically from the good old days.

However Montier offers the tantalizing proposition that we might be able to exploit this tendency with ‘time arbitrage’. However he also cautions that volatility might make this too difficult to exploit. Arbitrage usually has those kinds of catches.

Chapter 31 - Just a Little Patience 2

1. Increasing time horizons definitely benefits value investors
2. Attached Image (click to enlarge)

   
   
3. However patience is a killer for growth investors
4. Attached Image (click to enlarge)

   
   
5. I’m not sure if Montier definitively answers the question about ‘time arb’ but it turns out that focusing on value has a big performance benefit for growth investors
6. Adding a momentum filter also helps
7. However adding momentum to value has only a trivial benefit
8. What is important for value investors is to avoid “narrow-framing” which I take to mean not selecting too few stocks because only 40-50% of Value stocks contribute to outperformance in a given year. This also means not analyzing individual stock performance too frequently, because what is not hot today might be in a few years?

Chapter 38-40 Anatomy of a Bubble
I’m going to skip a few chapters that are focused mainly on sector value and risk management concerns specific to fund managers. This book is long enough as it is. This chapter sequence is interesting though because it deals with a favourite topic of any economic pessimist.

1. A bubble is more likely to be found when:
   1. The ratio of inexperienced to experienced traders is high.
   2. The greater the uncertainty over fundamental value.
   3. The lottery characteristics of the security are high (effectively a small chance of a big payoff increase the likelihood that people will overpay for an asset – growth stocks?). Bitcoin?
   4. Buying on margin is possible.
   5. Short selling is difficult.

   
   

Stages of a Bubble
Montier credits Herman Minsky for this model based on work by Fisher and Kindleberger.

Displacement
“An exogenous shock” shuts down investment in some sectors and opens it up in others and this creates a sort of boom. In 2000 it was the internet.
↓
Credit creation
A bubble needs liquidity like a fire needs oxygen. Monetary expansion. Soon the demand for assets exceeds supply. The Fed keeping interest-rate‘s too low for too long. Bailing out LTCM.
↓
Euphoria
Talk of a “new era”. New methods of valuation to justify outlandish prices. Overoptimism and overconfidence. Greater fool theory kicks in. Excessive leverage.
↓
Critical stage/financial distress
The insiders sell out. Increased IPOs. Increased equity issuance. Companies removing “dot com” from their name. Distress comes from debt accumulation. If inflation is low the cash flow is insufficient to service the debt. This causes deflation. Fire sales of assets. Fraud emerges. Enron. World com.
↓
Revulsion
Disgusted investors can no longer bring themselves to participate in the market. Collapse in volumes. The stocks that lead you into a bubble are not the ones that will lead you out. A lender of last resort steps in. Correlation between equities and bonds breaks down.


What to seek after the burst?

1. Focus on strong balance sheets
2. High quality earnings with strong cash flows
3. Lower capital expenditure

Also

1. Bear markets don’t have time limits
2. Focus on absolute returns
3. Bad news travels slowly because over pricing is easier than under pricing because shorting is more expensive than staying long

Chapter 40 is also about bubbles but it’s basically a lecture on the dangers of cynical greater fool markets, which I think is exactly the kind of market we’re in right now.

Bubble types

1. Rational/near rational bubbles
   1. (greater fool markets)
   2. independent of fundamentals
   3. cynical

   
   

2. Intrinsic bubbles
   1. react to fundamental news
   2. depend on fundamentals

   
   

3. Fads
   1. Driven by psychology and euphoria

   
   

4. Informational bubbles.
   1. too much emphasis on past price history
   2. One small event like a company missing its earnings causes a cascade

   
   

Conclusions

I’m going to finish the book here because I’m bored with it and it’s way too long. The chapters keep going to about chapter 54 or 55 and the topics get increasingly academic, looking at bubble echoes, corporate governance, ethics and basically increasingly abstracted away from the concerns of actual investors.

Academia has to explain everything where pragmatists only need to explain something important. This book is definitely an attempt to explain everything and so it does contain a lot of useful information but it’s also chock-full of pointless charts and the usual economic navel gazing. I will say that Pound for Pound it’s good value.

My main criticism is that it’s mostly a compendium of what not to do. It’s obviously important to know what not to do. However going forward I think I am going to avoid books that are heavy on economic theory and the psychology of human biases because I feel like we’re starting to churn through familiar territory.

There are a couple of chapters with actual strategies and they are quite excellent but they’re also buried deep in the middle of the book which is either a ploy to get people to read the whole thing or possibly a sign of a lack of confidence? Maybe that’s just a cynical observation from someone used to the hard-selling of a corrupted age of advertising.

The publication date of the book is 2007. But almost all the charts and examples end around 2003. This means when the authors are warning about the impending bubble they are five years off. It almost seems like when their predictions didn’t come true they shelved this book until the signs, warnings and cracks were appearing in the economy and then it made sense to publish it because what they were saying was finally happening??

Who knows. As they have repeatedly told us forecasting is pointless and predicting is hard to do.

There have been some new votes in the book poll which is great. However there is still a tie. So if you want to try and break that now is your chance.

The tie is broken and the next book is

Studies in Tape Reading by Rollo Tape (Richard Wyckoff)

Rollo Tape is of course, a pseudonym, for one of the grand old founders of the field of Technical Analysis, Richard Wyckoff.

His book is a classic, and highly original for the time. Also curious, is that unlike Gann, or Eliot his work (in my opinion) hasn't been widely picked up by the 'educators', possibly because some of it is actually helpful and would poison the flow?

Wikipedia credits him for the invention of a commonly used metaphor - that of the market as a single mind or individual, 'Mr. Market'.

1. Introduction

1. Success demands full attention; you can have no other profession or business
2. Study mistakes and find the why of your losses
3. Tape reading is gauging supply and demand, whether stock is being accumulated or distributed, and to what extent or if it’s being neglected
4. Tape readers play with a close stop, never venturing far from shore
5. Tape readers are Pullman coaches, smooth and reliable but ‘scalpers’ are jouncy jalopies. But it seems he is actually talking about scalping as far as I can tell.
6. Doesn’t carry overnight as the tape is silent then
7. Trade with only a small average loss, and earn profits over that, the tape reader’s goal is to generate steady income
8. The tape reader evolves himself into an automaton, who takes note of a situation, weighs it, decides on a course of action, and gives an order
   1. No emotions

9. Know:
   1. History, earnings, financial conditions
   2. The ways of the manipulators
   3. The different markets
   4. The effect of news and rumours
   5. When and what to trade
   6. The forces behind them
   7. When to cut losses and take profits

10. The tape reader needs nerve to stand a series of losses
11. Be secluded from tips and gossip
12. The tape is current news, the news is the past
13. The action of price in the light of news is the real info but must be weighed

2. Preliminary Suggestions

1. Don’t start with paper trading, because you must learn to play the real game where emotions can affect your choices
2. After reading everything associated with tape reading, start trading 10 share lots (do they exist now?)
3. Start small but with real money
4. Measure profit not in dollars but in points gained and lost
5. Causes of failure
   1. Lack of capital
   2. Incompetence (together these make 60% of failures)
   3. Overtrading

6. Choice of Broker
   1. This is an important choice but the advice in this 1910 book is not really relevant to modern traders?

1. Buy at the market price
2. It’s foolish to quibble over ¼ percent
3. If you can’t trust your broker get another. Amen.
4. The law of supply and demand doesn’t care about your order.
5. If you are wealthy buy a seat on the exchange and save commissions and execution time
6. Higher priced stocks move more, but commissions and taxes are the same
7. A few big stocks determine the general trend of the market
8. Trade only in a couple of issues, except in times when the industrials dominate the market
9. For a tape reader it’s better to trade in one stock than two or more.
10. Stocks have habits like people, personalities
11. Even if you trade in only one stock you must view the movements of the whole market. Smaller issues will retreat first.
12. Everything rises and declines in sympathy
13. Tape readers want stocks with the widest swings, and the broadest market

3. The Stock List analyzed
Since this book was published in 1910 most of the companies on his list no longer exist. I fear this chapter is not really relevant to modern readers, but there might be some parallels, like how Tesla, Amazon, Apple lead the market and secondary tech stocks might fall first before a decline?

1. Mentions the 1914-1916 ‘war’ markets but the cover and copyright clearly say 1910??
2. Various stocks are like a gigantic fleet of boats hitched together and tugged by ‘money situation’ and ‘business conditions’
3. Stocks move together by industry
4. Low-priced stocks rarely lead
5. When the ‘secondary leaders’ begin to rise it can signal that the rise in the leading stocks is over. These used to be called ‘indicators’ by pro traders
6. If a stock is strong under adverse news we can conclude that public holdings are strongly fortified and confidence abounds

4. Stop orders, trading rules, etc

1. Trading expenses
   1. The ‘invisible eighth’ (the bid/spread)
   2. This insidious item frequently throws the net result over to the debit side
   3. Tape readers must eliminate losses and cover expenses as quickly as possible
   4. Use a breakeven stop, but not too close. ‘Reactions must be allowed for’

2. Tape readers follow the immediate trend
3. Stops are also needed if they need to leave the ticker for a moment (step away from the keyboard in modern parlance)
4. Use a stop to protect against disaster overnight
5. 2 points maximum gross loss on any trade
6. ‘Points of resistance’
7. Not in favour of automatic stops though he outlines a method for using one, because the tape reader should be free to act as his judgment dictates, without feeling compelled by a hard and fast rule
8. Fear, hesitation and uncertainty - deadly enemies of the tape reader
9. Act immediately on a signal
10. Seconds can be more valuable than minutes
11. The tape is the captain (the pilot)
    1. The tape reader is the engineer who follows the captain’s commands
    2. They must obey commands promptly and with precision

12. Tape readers follow the immediate trend.
    1. They follow the line of least resistance (is this Livermore or did he get it from RW?)
    2. They go with the market, not against it

13. Avoid ranging markets (markets that swing within a radius of a couple of points)
14. Each risk should contain a probable 2-5 points profit, otherwise it is not justified
15. The tape reader gauges the boldness of a move, the impetus or energy with which a stock starts and sustains a movement, and decides whether it is likely to travel far enough to warrant going with it
16. The original risk in a trade can be gradually erased by clever use of stop orders
    1. Wyckoff prefers mental stops as these can be changed as circumstances require without delay
    2. Then he can exit at the market without wondering ‘where he stands’

1. A stock is fluctuating between 128 and 129. The ‘buying indication’ is at 128 ¾ If the indicator is true then price won’t break below 128. ‘The fact it did not touch 128 on the last down swing forecasts a higher up swing’. The point of resistance is now 128 ⅛ . The stop is at 127 ⅞ , ¼ point below the last point of resistance. At any time after it crosses 130 the operator may raise his stop to ‘cost plus commission’ (129). At the new high, the stop is raised to 129 ⅝ because the 129 ⅞ was the last point of resistance on the dip.
2. A series of higher tops and bottoms are made in a pronounced up swing and the reverse in a down swing.
3. Getting shaken out of a trade doesn’t prove the operator made an error. Some accident or untoward development affected the ‘rest of the list’. These unknown quantities make the limitation of losses most important.
4. Changing a stop so that risk is increased, in the face of such uncertainty, is folly, and the tape reader seldom does it. Risk must be eliminated, not increased.
5. Averaging is groping for the top or bottom. The tape reader must not.
6. No rule to limit profits.

 

1. Cover quickly and reverse if the strength of the reversal move warrants it.
2. Obey the tape
3. If a stock or the whole market cannot advance - the assumption is that it will fall. A market seldom stands still.
4. An operator must be ready to exit the market at the first sign of weakness.
5. Large volume trades make the ordinary public trader bullish, even if it’s only accompanied by a small advance, but this should put the pro on guard. The manipulator wants them to buy long stock at the top of the rally.
6. Those who chase rallies are the quickest to become scared at the appearance of weakness.
7. Watch other stocks to get cues about when to get in and out.
8. The tape reader cannot go with the trend until he is sure of a big swing.
9. Wyckoff describes a scenario where an operator goes short everything after a gap down in Gas.
10. News is reflected in price first. Don’t wait for an explanation.

5. Volumes and their significance

1. Market price is composed of both the bid and ask prices.
2. Big orders show the direction of the future trend.

 

1. The figures on the tape represent consensus of opinion, the effect of manipulation, and supply and demand, all combined. It’s thus more powerful than opinions, rumours or analysis.
2. Only real money trades mean anything regarding your ability.
3. Smaller lots are like the feathers on an arrow - they show the business part of the arrow is at the other end.
4. Rules revisions means some of the old tricks no longer work. A classic story.
5. Accumulation/Distribution =ranges
6. Markup = trend up
7. Markdown = trend down

6. Market Technique

1. Both the market as a whole and individual stocks are to be judged as much by what they do as what they do not do.
2. Wyckoff gives the example of a sudden 3-point dip in Reading after it opens up from the previous day. Union Pacific declines by ¾, Southern Pacific by ⅝ and Steel by ⅝, showing that they were technically strong, which is to say they were held by hands who "cared nothing" for a 3 point dip.
   1. Wyckoff compares the market to a mining core,
      
      Attached Image (click to enlarge)

      
      
      
      a cross-section of the composition of geological layers. “If it had been possible to have drilled in the market at the top of the foregoing rise, we should have found that the bulk of the floating supply in Steel, Reading and and some others was held by a class of trader who buy heavily in booms and bulges. These people operate with comparatively small margins, nerve and experience. They are exceedingly vulnerable, hence the stocks in which they operate suffer the greatest declines when the market receives a jar.”
   2. Wyckoff concludes that since Union didn’t react much it’s destined to go higher, relatively immune to declines. However this rise might be postponed for some time.

3. The tape reader has only so much time and capital so it must be used where it can have the greatest results. By operating with the potential future trend he improves his chances.
4. A long advance or decline usually culminates in a wide, quick movement in the leaders. An exceptionally violent movement after a protracted sag or rise usually indicates its culmination.
5. A stock generally shows the tape reader its intentions by its action under ‘pressure or stimulation’. Wyckoff uses the example lof the US STeel Corporation announcement of an open market in steel products. The news came out before the market opened. The whole country knew about it.
   1. “As the news is public property, the normal thing for Steel and the market to do is rally. Let’s see how it acts.”
   2. Steel opens ¾ down from the previous closing. ‘Perfectly natural’ based on the news. The stock oscillates between 47 ⅞ and 47 ¾ . Union Pacific however, is showing signs of rallying.
   3. Can Union lift Steel? The tape reader watches ‘like a hawk’ because he is going with the market in the direction of the trend, whatever that might be. Union is up, Pacific is reinforcing it, but Steel doesn’t respond.

Of course, eventually it declines, and Wyckoff is the hero of the short trend. He moves his stop lower, anticipating a further decline.

 

1. Tape reading is a study of force. You have to judge which side has the greater pulling power and then have the courage to side with it.
2. You have to spot the critical turning points which occur in each swing, and if you can spot these points, and put a close stop behind them, “you have much to win and little to lose.”
3. Not all responses are clearly defined. Consider the insider’s probable attitude to the stock.
4. “By casting out the unlikely factors”, the tape reader can reach the correction conclusions.
5. The market is constantly being put to the test by the floor traders who love to jump on any sign of weakness.
6. The expert tape reader is “seldom at a loss to know on what side his best chances lie. Other people do for him, what he himself would do if he were all-powerful.”
7. The tape reader is most interested in smaller movements but he must keep his bearings in relation to the broad movements.
8. In a bull market he expects a drop of 10 points to be followed by a recovery of about half the decline. If the rise is to continue, all of the drop and more will be recovered.
9. If a stock ‘refuses to rally naturally’ he knows that the trouble has not been overcome, and looks for further decline.

 

1. The market seldom runs for more than 3-4 consecutive days without a reaction. The more prolonged a trend, the more likely a reaction. Daily movements provide the best opportunities, but only in stocks that swing wide enough to secure a profit.
2. The expert tape reader is ‘diametrically opposed’ to the primitive methods of speculators. Wyckoff uses the example of a man who bought at noon and sold at 2 o’clock every day without fail.

“Few people are willing to go to the very bottom of things. Is it any wonder that success is for the few?”

7. Dull Markets and their Opportunities

Turn this sideways.

 

1. They occur after a period of "delirious" activity.
2. Traders who are due for a trim lose their nerve and the market becomes neglected.
3. These lifeless periods are like the close of a chapter. The forces that shaped price movements before have spent their energy and price settles into a groove, sometimes for weeks until affected by some influence.
4. We can never know how long prices will trend but when they are stationary, we know that from this point there will be a pronounced swing.
5. When insiders shake other people out of the market it means they want the stock for themselves. This is a good time to get in because then “Mr. Frick” and his friends are working for us.
6. A dull market that doesn’t respond to good news and can’t hold rallies will swing lower.
7. You can never know when a dull market will start moving so you always have to be watching.
8. More power is needed to start a thing than to keep it going.
9. Scalping fractions out of leaders in a dull market is not recommended, “precarious business”, says Wyckoff. The operating expenses can wipe out any profits especially as leaders may only move a point a day.

But if you insist, here is how to do it, according to Wyckoff:

 

1. Keep a chart with every ⅛ fluctuation recorded (What’s this? A magical box that records the chart automatically? Outlandish!)
2. Act based on support and resistance, in this chart the tape reader goes short at the market based on resistance seen at 181 ½ .
3. Attached Image (click to enlarge)

   
   

1. The downtrend indicates that pressure is heavy enough to prevent the rally from going as high as on the previous bulge
2. A point of resistance is seen at 180 ⅛. The decline is ‘checked’. Cover and go long
3. Watch carefully for the time to get out
4. The double stop
   1. The initial short trade had a stop at 181 ⅝ based on the assumption that if price broke through 181 ½ it would have to go higher.
   2. The stop is a buy stop for 2x the shares he has for his short
   3. The chance that price will hit the stop, and then decline is real and ‘anyone who cannot face this without becoming perturbed had better learn self control”.
   4. When he goes long, his stop should be at 180 or 179 ⅞ “for if the point of resistance is broken through after he has covered and gone long, he must switch position in an instant.”
   5. Failure to do this makes you a “guesser”
   6. Do not dilute this with other ideas.
   7. Only applicable to a dull market. Precarious!
   8. Commissions, fees, spreads, frequent losses, are too great a handicap
   9. Don’t do it!

We are not compelled to trade, and results don’t depend on how often we trade, but on how much money we make.

Watch for:

1. Sudden activity
2. Rise in volume
3. Advancing tendency (momentum)

Can it be this easy? In this day and age?