Technically Speaking, April 2015

Editor’s note: The MTA’s Annual Symposium always brings together the best minds in technical audience as speakers and attendees. This year’s event, held at the end of March, was no different. Each speaker presented useful trading ideas and attendees left the event with dozens of testable and practical ideas. In this article I am highlighting just a few of the many great insights into technical analysis that I heard over the two days. In the coming weeks, all presentations will be available online so that all MTA members can benefit from the speakers. We will also feature more about the Symposium in future issues of Technically Speaking.

Beyond the Benchmark: Applications for Active Investment Management offered attendees a chance to explore how top money managers outperform the market. Conference presentations showcased unparalleled industry experience and included discussions on how some of the best in the industry implement disciplined approaches to investing using technical tools.

Tom Dorsey kicked off the two-day event with a high energy presentation that highlighted the importance of discipline. Tom co-founded Dorsey, Wright & Associates in 1987 and continues to serve as President. He is the author of Point & Figure Charting: The Essential Application for Forecasting and Tracking Market Prices, Thriving as a Broker in the 21st Century and Tom Dorsey’s Trading Tips: A Playbook for Stock Market Success.

Tom applies discipline to every part of his firm and has done so since its founding. The firm’s approach begins with relative strength analysis of point and figure charts. This is not a widely followed approach to the markets but it intuitively made sense to Tom. He began his career updating charts by hand and then developed automated systems to do exactly what he had done by hand. Computers were used to automate what worked, not to search for new ideas that might work. It was this disciplined focus that allowed Dorsey Wright to grow.

In the past few years, growth has been spectacular. Dorsey Wright’s asset management business has more than tripled in the past three years to nearly $6 billion, including its largest ETF, the $1.6 billion PowerShares DWA Momentum Portfolio (NYSE:PDP), which has significantly outperformed the S&P 500 index since inception in 2007 and achieved a top-decile ranking among ETFs in its Morningstar category. Additionally, DWA launched the First Trust Dorsey Wright Focus 5 (NASDAQ:FV), which became the most successful ETF launch during 2014 by attracting more than $1.2 billion in assets in less than 10 months.

It’s interesting to note that the billions of dollars currently under management are based on finding new vehicles to implement the same disciplined strategy that Tom has used consistently since the 1980s. The lesson for attendees was clearly to stay disciplined.

Discipline can help investors react when the markets behave in unexpected ways, according to another speaker at the Symposium.

“Financial markets are the most perverse thing mankind ever invested – they are perverse because they always do the unexpected.”

 That’s the assessment of one of the brightest minds to ever study technical analysis, Walt Deemer, this year’s MTA Annual Award winner. As that short quote above demonstrates, Walt was also one of the most engaging speakers at the Symposium. Markets do unexpected things because people perform in unexpected ways. Human behavior is at the heart of the market’s actions.

In last month’s newsletter, we reprinted a memo from Walt explaining why early 1980 was the wrong time to sell McDonald’s and Philip Morris at 8 to 9 times earnings. As Walter wrote, the stocks were emerging from “big base” patterns. The big base pattern is the subject of another article in this month’s newsletter. That article is an extract of an MTA Journal article written by Bill Doane, who Walt referenced in his short talk at the Symposium.

At the Symposium, Walt noted how he has also considered McDonald’s and Philip Morris to be ill-timed buys when they were added to mutual fund portfolios. At the time they were bought, the stocks traded with price-to-earnings (P/E) ratios of more than 30. Investors were in the midst of the Nifty Fifty market craze and these were two of the stocks known as “one decision” stocks since they could be bought and never be sold. The one decision was when to buy since a sell decision would never be needed. The selling in 1980 was irrational, as he pointed out, but the buying had also been irrational.

The Nifty Fifty craze is an example of the human nature that makes the markets unpredictable. But, Walt, noted, the general outline of human nature is wholly predictable. Investors and traders are all looking for profits. They tend to pursue profits by thinking in the same way. In the 1960s the Nifty Fifty were all buys. In the 1990s internet stocks were all buys. Both times, high-priced stocks were considered undervalued because the Street had redefined value.

As Walt noted, the cause and the solution to the problem lies in the questions analysts ask. “In our search for answers, we often end up with consensus questions. The answer depends on the question.”

In the 1960s and the 1990s, the consensus questions were “how can we justify buying these stocks everyone loves even though we know they’re overvalued?” The answer involved assuming earnings would continue growing at a rapid pace forever. Had the question been “is it possible for these companies to grow fast enough to meet expectations?” the answer would have been “no” and losses from the bear markets that followed the manias would have been avoided.

As an example of the type of question he has about the current stock market environment, Walt noted, “in March six of 19 trading days closed with a gain or loss of more than 1%. What does this mean?”

Walt didn’t provide the answer but he did encourage the attendees to remember that “markets can do anything they want. For example, the stock market can’t go up six years in a row, but it has.” Walt wished he’d understood this market principle when he began his investment career.

Dean LeBaron, who founded Batterymarch among his many other accomplishments, was a mentor to Walt and a student of Walt’s work. The mutual admiration of these two market legends was on display as they were interviewed by Barry Ritholtz at the Symposium. Dean agreed with Walt’s view that investors must be prepared for markets to do the unexpected.

When asked what he wished he knew at the start of his successful career, Dean said he would have had “a better appreciation of the skills of others. I’d be a better listener. I passed up a lot of learning opportunities by focusing on what I was doing.”

Attendees of the Symposiums have always found listening to the wisdom of investment legends like Walt Deemer and Dean LeBaron to be valuable. Walt also noted that he found Bob Farrell’s work to be an important influence on his thinking. Barry Ritholtz noted he had compiled Bob’s “10 Market Rules to Remember” on his blog.

Bob Farrell retired from Merrill Lynch & Co. in 1992 as chief stock market analyst. Farrell was a legend on the Street and his ten rules still apply.

1. Markets tend to return to the mean over time.
2. Excesses in one direction will lead to an opposite excess in the other direction.
3. There are no new eras — excesses are never permanent.
4. Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways.
5. The public buys the most at the top and the least at the bottom.
6. Fear and greed are stronger than long-term resolve.
7. Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names.
8. Bear markets have three stages — sharp down, reflexive rebound and a drawn-out fundamental downtrend.
9. When all the experts and forecasts agree — something else is going to happen.
10. Bull markets are more fun than bear markets.

Also at the Symposium, in a breakout session called “The Checklist Manifesto: Fidelity Technical Process,” Mark Dibble and Darren Chabot provided a rare glimpse into how the mutual fund giant operates. Technical analysis is important to Fidelity.

Mark joined Fidelity Investments as a Senior Technical Analyst in March 1994. His success led to his recognition as Institutional Investor’s “Best of the Buy Side” in 2002. Prior to joining Fidelity he was a Vice President of Morgan Stanley in New York, providing technical research to the Global Equity Derivatives and Equity Research Departments. Before joining Morgan Stanley in 1984, he did technical research for Cowen & Company in New York. Mark has 31 years of investment experience. As he explained in his presentation, Mark’s approach combines the traditional pattern recognition discipline of Edwards and Magee with momentum and sentiment indicators. He works with Fidelity equity portfolio managers, analysts, and traders and focuses on the U.S. industrial, technology, telecom and utilities sectors. He has portfolio oversight on the Technical Research Pilot Fund.

Darren joined Fidelity’s Technical Research Department shortly after Mark in 1996. Initially he was a chart designer for the Fidelity Chart Room, a developer of deep history market data and a researcher creating technical studies. He became a technical analyst a few years later after experimenting with various styles of technical analysis. Currently he focuses on financial, health care, consumer staple, and small cap stocks combining old fashioned chart reading and mechanical overbought / oversold screens.

Technical research at one of the largest mutual funds in the industry may have a very different function than it does at boutique shops, investment banks or hedge funds. Emphasizing a theme introduced by Tom Dorsey, both Darren and Mark emphasized the importance of a disciplined approach. Interestingly, these two veteran technicians of the same department in the same firm have each developed distinct and different processes and approach.

Darren spends most of his time researching large cap stocks but worked with small caps earlier in his career. He observed “small caps are not as technically friendly.” Whether looking at large caps or small caps his process is eyeball driven. He is looking for trends about to change because of the timeframe he works within. He is communicating his ideas to large fund managers who will need time to act on his recommendation. He described his approach to the markets as “getting paid starting one month after you make a buy recommendation and stopping one month after the sell recommendation.” This is a unique challenge that highlights the diversity of technical analyst positions.

Day to day, Darren is responsible for analyzing the holdings of three funds. He provides recommendations to the managers of those funds and is largely focused on relative strength. From a technical perspective, mutual fund managers largely rely on relative strength to outperform their peers. He is able to maintain opinions on hundreds of stocks because he can often make assessments within seconds of looking at a chart. A chart can be described as good or bad depending upon whether or not it meets his view of strength or weakness.

As noted above, an article about Fidelity’s approach to technical analysis can be found elsewhere in this issue.

In a presentation called “Why Technical Trading Strategies Often Don’t Generate the Same Results From the Markets, as Compared to their Results During Research” K.D. Angle, CTA, CEO Angle Capital Management LLC., offered several valuable insights into how markets work. K.D. runs a long-term, trend-following, rules-based managed futures program that offers a broadly diversified portfolio using markets traded in the major exchanges in Europe, North America and the Pacific Rim.

K.D. Angle began learning about the futures markets while working for his father’s oil and gas company. It was here that he also learned about the importance of trading the markets conditions that exist right now instead of imposing your own bias on the market. One field his father developed was producing low-quality oil that was difficult to market because of its high helium content. This became the basis of the world’s largest helium plant as K.D.’s father understood the value of the well’s output was the unexpected helium rather than the hoped for oil.

After selling the world’s largest liquid helium plant in November 1978, his father invested $2 million in 2000 gold futures contracts. Six months later this market position was worth $100 million. His father eventually closed the position for a gain of more than $60 million on his first futures trade. After that, K.D. noted there were two $20 million losing positions as his father learned about the markets.

K.D. began trading the futures markets in 1979 and developed his first rules-based trading strategy in 1984. In 1985 he created a newsletter called “The Timing Device” that specialized in making specific trade recommendations in the futures markets. Its market calls were monitored by Commodity Trader’s Consumer Report (CTCR) along with 25 other letters. In early 1987, the newsletter was featured in Forbes magazine as being the #1-ranked letter of 1986 according to CTCR. Within 90 days of the Forbes article, Angle’s subscription base expanded to eight countries.

Despite its successful record, K.D. told the audience at the Symposium, he had a difficult time keeping subscribers. Talking to other successful newsletter writers, he learned that marketing could be more important to attracting and retaining subscribers than the success of the trades. One expert told him he needed to create a problem in the mind of potential subscribers and then explain how the newsletter addressed that problem. This was not appealing to him and after 1995, K.D. retired the newsletter and went into asset management on a full-time basis so he could invest the majority of his time and resources into researching and developing rules-based strategies.

He now manages three programs. The oldest began trading in 2000. In 2003, he introduced a second investment program known as the “Keck Program.” In 2010, he created a third product which combines the Genesis and Keck programs into a single allocation product known as the “AIP Program.” The three programs currently manage approximately $120 million.

K.D. did not discuss the performance of his funds but understanding his performance helps understand the importance of his insights. The Genesis Program has delivered a total return of 767% since inception in April 2000 through February 2015. Over that same time, the S&P 500 gained 45%.

There were a number of important points in this presentation but two stand out and apply to all technicians whether they look at futures or stocks.

K.D. believes the most important part of market research is to identify what you missed in your research. This idea ties back to Walt Deemer’s point that the markets will do what they want to do. K.D.’s point is that through your research, you will know how your strategies will react to the unexpected. To be sure your strategy will react to the market action as it unfolds, your rules must be specific because the computer system does only what you say to do.

He also noted that there is often no reason to be in a market.

“How often does a market move vertically? That’s the only time you’re making money. The number of trading days that contribute to the trend is about 12%. Prove to me why I want to be in.”

Over the long term, he’s taking exposure on the long or short side less than 50% of the time to any market. This limits his risk and by trading a diversified portfolio he is able to participate in the largest market moves when they occur. His results, shown above, speak to the wisdom of this approach.

Each speaker contributed unique insights to attendees and we will have more of those insights in the next few issues of Technically Speaking.