The stock market is a lot different now than it was in the 1950s. The most pervasive changes derive from five dominant realities, none of which played meaningful roles in the market only three decades ago.
The computer: Has revolutionized virtually every aspect of how markets operate and how they are analyzed. The effect on technical analysis is no exception.
Institutional Dominance: In the fifties, the public accounted for well over half of market volume. Now institutions account for over ninety percent. Institutional managers are generally employees who trade with other people’s money. Their motives are entirely different. They trade with larger amounts of money. The nature of trading is therefore very different than in a public-dominated market.
Strict and restrictive insider laws: in the past, "leaked" information was often visible on "the tape," which is also to say on stock charts. The existence of inside information in good part provided the rationale for technical analysis. Today, since information is not nearly so likely to be released in an (illegal) pecking order, there are many more surprises. Consequently, stocks are much more subject to huge gaps without warning. The old corrupt way of disseminating information embodied a certain order to the way prices unfolded. Programmed buying and selling: A phenomenon by which the market is used and abused by the privileged. Takes more money out of the public’s pocket in a year than all of the "insider selling" in history. Skimming (which this is a form of) is even illegal in gambling casinos.
Derivative products: Various kinds of futures and options divert capital away from the basic function of the market, which is to provide capital to industry. When you bet on your favorite football team, the team doesn’t benefit in any way. When you bet on a company instead of investing in it, the company doesn’t benefit either. Direct trading in stocks (even though it is usually in the "secondary" or "after market") makes the primary market possible. Some day these products may come back to haunt us in way we can only guess at. Other developments that have contributed to the changing nature of the market, though, not as forcefully as the above, are globalization, index funds and possibly hedge funds.
Market tools were simpler and cruder thirty years ago than they are today. The justification for many of the tools in use was often rooted in the simplicity of their computation. For the times, this was sensible. Point-&-figure charts, for example, were much easier to keep up than bar charts. This was their principal virtue, although they were inevitably thought to be endowed with magic powers.
The advance-decline line was a simple way of getting a feel for the "breadth" of market strength or weakness. It too was sanctified. The advance-decline line is here to stay because many technicians feel it IS market breadth and an indispensable key to defining the market.
These same people no longer insist on driving cars with 3-speed manual transmissions. But they won’t give up their advance-decline line. There are many better ways to measure market breadth.
But this is not about market breadth. This is about the attitudes of market technicians. There have always been brilliant traders and investors, who set themselves apart by their ability to think about the unthinkable. But for the hoi polloi, attitudes and techniques didn't change much for decades.
It was in the sixties, with the depression and World War II fading into ghosts of the past that a kind of intellectual awakening occurred. It wasn’t all good to be sure. It was a turbulent decade, wrought with social problems and a youth culture revolving around drugs and something they thought of as music.
But it was a time in which people lost their fear of the status quo. It affected every nick and corner of the land--- including, what do you know, Wall Street.
Today, instead of becoming a slave to techniques developed to suit an age of primitive technology, the wise technician will look for change and welcome it. Changes will take place whether or not he is paying attention. Nothing he learns will be permanent, all tools and approaches will become obsolete. The survivors will be those willing not only to accept the future but also to discard the champions of the past.
The really big changes in technical analysis came with the computer, though a change of attitude for some reason began to stir before its use became commonplace in market analysis. Joseph Granvilles’ book Fifty-five Daily Indicators for Stock Market Timing was an immense success. Looking back, I see the wide acceptance of the new ideas in this book as a milestone in breaking away from the doctrinaire edicts of Edwards and Magee (The Technical Analysis of Stock Trends).
I personally served as a catalyst in the development of a totally new and ambitious tool. At the time it was called Tick Volume. It is now known as Money Flow. In the late 1950s I began tallying individual transactions on the New York and American Stock Exchanges. Nobody before had ever embarked on a systematic analysis of individual transactions or attempted to devise indicators based on the flow of individual transactions. Why, I don’t know. The idea seemed rather obvious to me.
I had become fascinated with tape reading. Tape readers paid a lot of attention to the size of transactions and whether they were occurring on "upticks" or "downticks." I learned from a book by the late Humphrey Neill, Tape Reading and Market Tactics, that a company in New York, Francis Emory Fitch, published daily lists of all transactions on the New York and American Stock Exchanges. These were used by brokerage firms to verify disputed prices of transactions.
So I started marking these sheets each day. At first, since there are only 24 hours in a day, I marked only transactions of $100,000 or more. I used a red pencil and put a mark to the left of the volume on an uptick, to the right on a downtick. I then counted the upticks and the downticks, found the difference, calculated some moving averages, and plotted the results on charts.
Fitch had several years of back sheets and I bought them all. Soon I found that I had a really useful timing indicator for the overall market, which I called The Worden $100,000 Indexes. I plotted the results as oscillators. I found that, unlike any indicators I was aware of, the $100,000 Indexes showed great bursts of "big money" buying pressures early in intermediate or cyclical bull markets. This buying pressure diminished as the bull move progressed, rather than rising to an overbought climax.
Above all, I notice that the profiles of my indicator lines often diverged markedly from the direction of price itself.
About that time (1960), I began publishing my results in a market letter, The Worden Tape Reading Studies. I must say that it was clearly the right product at the right time. I doubt if any market letter ever made a more promising debut. For many years it was one of America’s leading stock market newsletters.
Soon after I developed the $100,000 Indexes I began working with individual stocks. This was a lot more work. I wasn’t yet at the point where I could afford to hire a room full of people to "mark the Fitch sheets." To start with we tallied only transaction of 1000 shares or more. I arrived at a number of ways of calculating individual stock indexes. The results were promising to say the least.
The work I was doing had great appeal to market technicians of the time. It seemed like a gigantic step forward. There had been nothing like this before. The essence of the approach was that my various indexes seemed to be separating "big money" activity from "small money" activity. Implied here was "insider activity". It was available instantly, not a couple of months later in bureaucratic reports.
It was amazing how word of these new "magic indicators" spread like wild fire. At one point the New York Stock Exchange called me for information on certain individual transactions. I referred them to Francis Emory Fitch. On a number of occasions the SEC called me for advice on how to detect manipulation.
At that time, institutional activity accounted for only about a third of the volume. Most of the trading volume came from the "little guy"—the public.
Soon I started a small staff tallying every single transaction every day. And we went back and did it all retrospectively. This is what we needed for Tick Volume. This indicator was calculated by adding the volume on upticks and subtracting on downticks, much like OBV (On Balance Volume). (Incidentally, OBV and Tick Volume were developed completely independently of one another. Joe Granville’s book on OBV came out just a few months after we introduced Tick Volume. His book had obviously gone to press well before we came out with our new indicator.)
About this time Scantlin Electronics came out with the Quotron desk quotation device. This meant a new source of stock market data, this time on magnetic tape. We hired computer service bureaus to do the tallying for us.
This was astoundingly expensive when I look back. In fact, even ten years later in the 70s, when I had my own computer, I remember paying $1.00 per day per stock merely for price and volume quotes.
Exorbitant as it was, we became computerized just in the nick of time. Volume on the NYSE was expanding so rapidly that we could never have handled the job by hand. When I began tallying the Fitch Sheets, volume on the NYSE ran about 2.5 million shares a day. When we switched to the computer in 1966, volume was averaging over 6 million shares and climbing fast. Volume had so overtaxed the equipment of the time that they closed the New York Stock Exchange at two o’clock every day for about a year to hold volume down and to provide more time for the back offices to keep up.
By the early 1970s things had changed a lot and they were still changing fast. Adam Smith’s book The Money Game proved the definitive word of the times. Smith, among others, was able to foresee that institutions were taking over the market in entirety. There was talk that the public would not even be allowed to trade directly in stocks.
I had been able to see for a long time that Tick Volume was losing its effectiveness. From the very beginning I had noticed a slight negative bias in my indicators. This was because a greater number of large transactions occurred on downticks than on upticks. The larger the transaction the more likely it would be on a downtick. (You can observe this yourself. As a direct result of my work, Barron’s has been publishing tallies of large blocks in the Market Laboratory section.)
And there were other uncontrollable aberrations as well. With over 90 percent of trading coming from institutions, the entire rationale of Tick Volume was lost. The original idea was that it could ferret out "big money" trading, the implication being that "big money" was apt to be "smarter money" than "little money."
Now what we were having was "big money" trading with "big money." One indicator that we kept, called the Power Index, a gigantic Tick Volume tally for the entire NYSE, had totally lost the power to turn positive. It had been fluctuating below the zero line for years.
Well before that, I had started experimenting with other price/volume indicators --- some of which worked very well. However, I had to admit that none of them ever seemed to work quite as well as the "original" Tick Volume in its early days.
In what way were they inferior? They did not have that incredible power to contradict price direction. At its best Tick Volume could "show you" buying pressures in the form of positive numbers, while the price was falling. The effect was sensational. Other indicators, to various degrees, have the power to diverge, which is a form of contradiction, of course. But Tick Volume could literally stand up and shout at the price, "Hey, you’re going the wrong way!"
Tick Volume’s strongest point was also perhaps its weakest. It was often too early. This was true at both tops and bottoms. This is precisely what contradiction is.
Further, there are many reasons to either buy or sell a stock. Not all of these involve the expectation of a specific move in price. Even if the expectation is there, the buyers or sellers could be wrong. Not everybody who trades in big quantities is smart.
And on it goes. A price advance is not the inevitable outcome of systematic "big money" buying. And vice versa.
But when it comes to probabilities? All other things being equal, I’d rather be in the stock that the "big money" is buying every time. A stock revealing signs of "sponsorship," signs of systematic "accumulation," that’s for me. Perfection? In its best days, Tick Volume was never perfect. Democracy isn’t perfect either. But what is it they say? It’s just that it works better than any other form of government.
Ironically, as I discarded Tick Volume, a number of brokerage firms had become very interested in it. In fact, I had an arrangement with one New York firm that allowed them to use it for their institutional clients. Others had started doing the same thing.
Some people have asked me why I never sued any of these firms. Two reasons. First, mathematical formulas weren't patentable at that time (today certain software decisions suggest this is no longer completely true). Second, by the time they started horning in, Tick Volume wasn't working right anyway and they weren't damaging me. I was losing interest in it.
I can’t deny that some of those guys irritated me, though. Particularly the one who named it Money Flow and pretended it was something new he had invented. That brings to mind a funny incident. Years later I happened to be talking to a salesman for an institutional data distributor. He had no idea who I was other than what he assumed to be a prospect. He was pitching Money Flow. He told me that Money Flow was thought to be responsible for the success of Salomon Brothers. I told him I would think it over.
Didn't any of these firms run into the same horrendous aberrations that I had? Sure. They just don’t care. In one case, they noticed that the largest transactions were causing an unmanageable negative bias. So they deleted all transactions of 10,000 or more shares. Just threw them out, compounding the chances for aberrations. I suggested to them that it would make more sense statistically to truncate these large transactions to a less dominating size. They suggested that what they had done seemed to work well enough. That operation was later sold to a well-known bank.
To this day, that bank still sells Money Flow to institutions with and without 10,000 share transactions. Like hot-dogs, with or without mustard.
I doubt that anybody actually makes investment decisions using Money Flow. Every now and then I check it out for one stock or another. It just doesn’t work anymore. I suspect it is used as sort of a "sales prop" by some money managers: good for show but not for dough.
I do hope this does nothing to erode your confidence in the institutional money manager looking after your money.
A few years ago I entered into a joint venture with a regional brokerage firm to develop a price/volume indicator designed for institutional use. Brokerage firms like to sell special products for what they call "soft dollars" –that is, for commissions instead of hard money. It’s very profitable, since institutions don’t mind paying big with what they probably think of as something like "funny money."
I developed an indicator based on the flow of individual transactions. But since I knew Tick Volume didn’t work, I based it on another concept I had been toying with for a number of years. Instead of using upticks and downticks, I tallied price and volume changes at specific times of the day.
For reasons not worth going into, in writing computer programs, I found it useful to improvise a formula that could temporarily mimic the indexes I was building based on individual transactions. The mimic-index was based on day-end data. As I progressed, I found that the "temporary" mimic-index worked better than the other. This was because I was never able to completely eliminate the aberrations inherent in the flow of individual transactions in an institutionally dominated market.
Although Worden Brothers doesn’t want me to reveal how this indicator is calculated, I will tell you something about it. About thirty years ago a young man walked into my office and showed me an indicator he had developed that had a "a power to contradict" – much like Tick Volume. I had popularized this concept of contradiction through my work and writing at the time. His method was not based upon individual transactions.
Hundreds of people had brought me ideas (usually the valuable secret they whispered to me was an idea to calculate OBV by multiplying price times volume instead of adding). Nobody had ever brought me a really good idea, not even a decent one.
But he had a very good idea. Since Tick Volume was working very well and I had a small research and publishing organization of about only twenty people in total, I didn’t see that I could do justice to his abilities. I suggested he take his ideas to New York, which he did. He became very successful and well known. His name is David Bostion. His idea was to take the difference between close and high, and subtract it from the difference between close and low. A very ingenious idea!
I tinkered with it from time to time, but I was always troubled by what seemed to me excessive spikes at extremes of buying or selling. Later Larry Williams, whom I’ve never met, came up with something similar for commodities. I heard something about some litigation’s between Bostion and Williams. I don’t know who won. Mark Chaikin later came up with a similar idea that combines price and volume.
The MoneyStream has certain similarities to Chaikin’s indicator. However, I discovered what I consider a logical error common to all three of those approaches. Which is all I have to say about how the MoneyStream is calculated.
The MoneyStream embodies both price and volume, although if volume is not available, an automatic adjustment takes place in the formula and the indicator is calculated and displayed. The pure price version has less power to contradict than that embodying both price and volume. But it is quite useful nonetheless.
I find that the Cumulative MoneyStream (CMS) moves much like OBV, but it has a bit more power to contradict. The way to interpret it is simple and direct. Normally, the MoneyStream will form a pattern exactly like the pattern of the price. This tells you nothing, except that "nothing is broke." Which let me add, is well worth knowing.
If the MoneyStream is stronger than the price pattern, this is a forecast of strength to come. This is bullish. If the MoneyStream is weaker than the price pattern, it is bearish. To help investors see these relationships easily and consistently; I developed a technique using linear regression lines. Here is how it works:
The price profile and The MoneyStream are set up in windows and on scales that make them directly comparable.
A short-term and long-term regression line are put in each window simultaneously and automatically. (The shorter-term line is 30 bars, the longer-term line 100 bars.) The analyst can then eyeball the "slopes" of these regression lines for an easy-to-assess comparison of price performance versus the performance of the MoneyStream. Remember when the slopes differ, it is the MoneyStream that is considered to be the more valid interpreter of the strength of the trend.
Some really impressive divergences develop in The MoneyStream profile when compared to the profile of the price. As you will learn, I have developed another indicator with a greater power to contradict, but The MoneyStream has unique virtues of its own. It embodies an ability to detect changes in momentum and is often serves as an invaluable timing aid. I use the MoneyStream in tandem with another indicator, an indicator with a unique power to contradict and to bring out underlying patterns of systematic accumulation or distribution that would otherwise lie hidden beneath the surface. I call this indicator BOP (for Balance of Power).
I developed BOP about five years ago. I have been using it privately together with CMS to make investment decisions for more than four years. I rely on these indicators heavily. Neither of these indicators has ever been published or described in print or in any public forum before.
BOP AND CMS ARE OFFERED EXCLUSIVELY AS FEATURES OF TC2000. Their formulation is the intellectual property of Worden Brothers, Inc. who has purchased all rights. (Since the three Worden brothers are my sons, I made them a good deal.)
Necessity is usually the mother of invention. In the case of BOP it was not. I wasn’t trying to develop anything. I thought CMS was the best I could do in a price-volume indicator, and I was content to hope it would keep working.
The truth is, I am willing to admit, I developed BOP playing with my computer. By playing, I mean that I like to write programs. I don’t enjoy learning software written by other people.
Just for the fun of it, I’ve written application programs in such diverse fields as handicapping football and teaching foreign languages.
I generally use a chart program I wrote myself because I can tinker with it and make endless changes. I know darn well my son Chris, who is a far better programmer than I am, would never let me tinker with the source code of his TC2000. (Good as he is, I taught him his first algorithm, and I have a pretty good idea of how Arnold Palmer’s father felt.) BOP was based on a concept I hit upon many years before. For some reason I could never get an indicator based on that concept to act the way I thought it should. Each time I tried, I wound up abandoning the project.
As I said, I was just tinkering. I don’t know what set me off on that old concept again. I do remember that, once I started on it, I knew that I could make it work. I think this was just a matter of long experience, with the computer as well as with market indicators. (I started writing computer programs about 1970.)
Anyway, this time it fell together without a hitch and worked exactly the way I expected it to.
Let me give a word of advice here to anybody who would like to develop some of his own indicators. I never shotgun an indicator. That is, I don’t say to myself: "Hey, that OBV of Granville’s is great. But he adds the volume each day according to the sign of the net change. I wonder what would happen if I multiplied the net change times the volume instead of simply adding."
I would never use such an approach. I always know exactly what I am looking for and how I expect it to work. If I hadn’t used this approach, I would never have dreamed up a workable indicator. You see, there are thousands of combinations of parameters and mathematical operations I could try using the shotgun approach. How many would have any value? One in a thousand? One in ten thousand?
Before I put together an indicator, I know what it will solve for me, how and why?
An indicator is merely a manifestation of a concept I already understand. The indicator is a way of communicating that concept.
Take OBV, for example. I didn’t invent it, but I can assure you I know exactly how Granville’s thought process worked. It went something like this. "I am tired of laboring over these charts, meticulously comparing day by day price movement with expansions and contractions of volume. It’s hard to see and hard to keep track of the positive and negative events in my head. What am I looking for? Why, I guess I’m just looking for sort of a running tally of the total volume on advancing days versus the total volume on declining days. Let’s see, there must be a more systematic way of doing that and saving myself some time. In fact, if I tally these comparisons systematically, I will probably see some things in the pattern I would otherwise have missed. I think I’ll give it a try."
You see, the indicator is a statistical interpretation of the facts in a raw form. But unless you know how to interpret the facts in a raw form, your can’t think of an indicator. You can try until you’re blue in the face. The indicator is a statistical depiction of the way you have already learned to interpret raw data.
Generally, a useful indicator solves a specific problem you have been having in interpretation and, especially, in consistency.
BOP is a marvelous indicator. But it doesn’t tell you whether a stock will go up or down. By itself, it can hardly be described as a pinpoint timing indicator. What it tells you is whether the underlying action is characterized by systematic buying (accumulation) or systematic selling (distribution). This is exactly what I designed it to be. BOP is a statistical interpretation of a concept that ferrets out subtle evidence of systematic buying or selling. The process of development, like any of my indicators, developed in a similar fashion to the fantasy of how Joe Granville thought up OBV (described above).
BOP fits into a category of devices that I call "trend quality" indicators. It tells you about the quality of the underlying action. From this you can infer the various tactical judgments you must make to arrive at an effective decision. BOP, for example, can help you formulated a judgment as to the vital risk-reward ratio of a prospective trade. It can help you determine whether the supply-demand balance will be in your favor. It will help you spot changes in the character of a stock’s action.
Just the other day a friend called me and asked for some input on a stock he was thinking of buying. His interest was based on the prospects for a hot new product coming on the market. I checked the chart. BOP displayed a mildly negative, partly ambiguous pattern. The important thing was there had been absolutely no change in the general character of BOP following the announcement of the new product. If the product could genuinely impact the company’s profit picture, there would be plenty of people in the industry that would recognize it. It would very likely show in some kind of a change in BOP. In this case there was nothing on the chart suggested the stock was about to change its languorous descent.
So you see, before I actually begin to show you examples of BOP in action, I want to caution you that there are no magic bullets, no way of sparing you the necessity of thinking. One of the first things to understand about chart reading is that most charts are ambiguous most of the time. You can’t expect to pick up a chart at random and demand: "What is BOP saying here? What is CMS saying? What is OBV saying? Most of the time a randomly picked chart has only one thing to say: "No comment!"
But you see, the amateurs are constantly trying to force opinions out of their charts. They are sure there is a message in every chart if someone will just, please, show them how to read it. Consequently, think of the time they waste chasing those windmills. Think of the bad decisions they make.
Look at a thousand charts. If only one gives you a clear message, isn’t that enough? It is, yes, providing that you recognize that the other 999 did not have anything to say. But remember you know more about a chart than just what you see. You know such things as whether there have been earnings surprises, litigation, fierce competition, changes in management, what other stocks in the industry look like, how the market in general is doing.
Interpreting a stock chart is like reading the expression on somebody’s face. You will see far more in the expression of somebody you know. The mere absence of expression when he should be glowing with joy would tell you much.
The examples I choose to show you will all be selected because they demonstrate BOP and/or CMS performing at their best. Keep in mind that in real life there are always more ambiguous charts than anything else. Learn to hold out for the best ones.
One more thing to remember about any chart. No matter how perfect it is, no matter how classic, there are few situations that cannot be torn asunder by the action of the overall market itself. The most bullish patterns, the strongest support – it will all snap like straws in a hurricane if the overall market goes on the rampage.
Not only are BOP and The MoneyStream excellent indicators in their own right, but they complement one another nicely as well as acting as checks on one another. They are based on entirely different concepts.
You will find, not uncommonly, that BOP and The MoneyStream disagree. Most of the time, you will probably restrict yourself to trades in which both indicators are in gear.
Both indicators represent significant steps forward in the way they are presented for ease of interpretation. The MoneyStream is very convenient with its automatic display of linear regression lines for ready comparison of the respective strength of trends in CMS and the price.
The BOP scale runs from +100 to –100. The indicator itself can rise above or below these extremes, but it is relatively rare. When it happens, we just truncate the profile at the top or bottom of the chart. We believe it is more important to keep all the charts on the exact same scale than it is to include the "outliers" on the chart.
Some will ask whether the direction of the BOP profile is more important than whether BOP is above or below the zero line. The answer is that above or below the zero line is most important, especially when it represents a change in relation to the price.
But whether BOP is getting stronger or weaker is also important. How do you know were to place the greatest emphasis in an individual situation? That is the art of it my friend. If it were so cut and dried that it was mechanical, it wouldn’t work for anybody.
BOP, which has incredible power to contradict price movement, is shown in color: Green for buying pressure, red for selling pressure, yellow for a more neutral area of lighter buying or selling.
These colors are repeated in the price bars as well as the bars in the indicator itself. This is a very effective way to spot changes in buying or selling as it reflects in the price pattern. For example, you will often find that the price bars have turned red well before a top is reached.
Actually, it would be possible to interpret BOP based only on the colors in the price bars, without even seeing the indicator itself. I know this to be true, because for a while that’s the way I did it. In my own program I can’t display indicators simultaneously the way Chris has it set up in TC2000. Therefore, I used to get the price bar set up with BOP colors, then put CMS in the indicator window.
The TeleChart setup is much more convenient without being cluttered. A panel with three windows pops up and overlays the basic bar chart. You can still see the right portion of the underlying chart.
This is very powerful, not only because you can see CMS and BOP on the same panel, but also because you can, if you wish, view them in a different time frame than that on your underlying chart.
The way is opened for very convenient and powerful comparisons, limited mainly by your own ingenuity and imagination.
The predictive value of BOP and CMS tends to diminish with the size of the company. This is because the market action in large, blue-chip type stocks is more efficient. Such stocks are held heavily by institutions. They are analyzed carefully by dozens of analysts. Virtually everything there is to know about them is known. Further, the management and boards of such companies tend to be more concerned about personal liabilities under the insider laws. Great care is taken to prevent leaks.
Patterns of informed accumulation or distribution are less likely to occur in the big blue chips. When interesting patterns do appear, they may be less trustworthy. Also, many large companies are included in the S&P 500. These companies are included in large index funds (not to mention in "baskets" of stocks used in "programmed trading" and arbitrage schemes). Index funds buy and sell them under the automatic guidance "programmed trading" and arbitrage schemes. Index funds buy and sell them under the automatic guidance of computers in order to mimic the S&P 500 average. These forces can result in unpredictable and sometime unexplainable behavior patterns. Particularly susceptible to these various aberrations is BOP, which is an indicator almost purely of buying and selling. BOP cannot tell you the why or the who of the buying and selling evidence it detects. The MoneyStream, while also an indicator of buying and selling, embodies significant momentum elements.
I should point out that this kind of phenomena is true of technical analysis in general (which shouldn’t be surprising since all technical analysis is more or less trying to accomplish the same thing).
Having warned you about big stocks, let me carry it full circle and say that technical indicators often do work with big stocks. A "change of character" in trading usually means something no matter what kind of a stock it is. Just be aware of the potential difficulties. Not only must the stocks of larger companies be analyzed with caution and perhaps greater imagination, the same can be said of market averages.