Schulz, The Intelligent Chartist, part 2

Today’s theme is trend chasing, exhibited both in running after an “obvious” trend in earnings (fundamental analysis) and in jumping onboard an “obvious” trend in prices (technical analysis).

“At a certain point, a price trend will become obvious [to the average chart player] on the chart; and by having reference to the charts, he can pick out ‘the best-acting issues, those going up the fastest.’ When can he identify a stock as a fast climber? Not until it has been going up quickly for some time. But that means it has come some distance already, that it has exhausted a worthwhile part of its ultimate scope, and that it has clearly entered the trend-chasing phase. The ‘technical approach’ at this stage looks just as logical to the chart player as the fundamental rationalizations look to the growth-stock investor, and just as sound as the economic reasons look to the business man in search of wider profit margins and untapped sales areas. The chart player’s ‘signals’ work – for a while – and his sell stop orders don’t get touched off very often: he’s found the ‘system.’ Actually, all he has found is a different vocabulary for what everybody else is doing at the same time.”

. . .

“[O]ne of the few flat statements you can make about the stock market is that any price trend will eventually be carried to excess. Actually, this holds true for all kinds of stock market trends, big and little. In the gentler trends, the ‘extreme’ is just comparatively moderate, because they don’t attract so many followers. The more pronounced trends are noisier and very much self-advertising; so they pick up a steadily increasing population as they proceed, until finally and inevitably they become overcrowded; when they reverse, the bang is that much louder. You can demonstrate the process and consequences of overcrowding in terms of the simplest arithmetic: a great deal more stock can be bought during the late (irrational) stages of an uptrend than can be sold at its final peak. (In reverse, the same fact is true of downtrends.)”

. . .

“A primary rationale of technical stock market analysis rests on the tenable assumption that the price movement itself is a function of all the variables – fundamental and otherwise – that motivate changes in supply and demand; the conclusion being that careful analysis of the price movement can yield results of superior quality because it has, in effect, taken ‘everything’ into account.

“The original premise for responding to so-called chart signals therefore is that no worthwhile trend can materialize without valid non-technical causes; thus, there is no need to investigate these causes themselves, - the signals will suffice. This is not essentially a ‘know-nothing’ attitude; it is merely an attempt to find the easy way out of a difficult problem; and because there is no easy way out, the attempt eventually must fail.

“It fails because, as noted above, all motivations become hollow in the final phase of an ‘obvious’ trend. Somewhere along the line, fundamental motivations begin to lose the impact needed to produce the signals that presumably indicate another extension of the existing trend. The signals still ‘flash’ because some fundamental trend chasing does continue to the very end, but the response to the signals now comes overwhelmingly from the chart playing sector. And after the chart players have made their commitments, there is little or no follow-through from other quarters, technical or fundamental. The signal traders thus find themselves locked into stale positions.”

. . .

“The lure of the unearned increment and the wish to obtain it with a minimum of mental effort have helped to perpetuate the signal as an imperative. But in spontaneous price trends, the signal is no more than evidence of continuing trend momentum, - which may be strongest and least mistakable in the late, irrational stage of an established trend, where it is also at its least reliable. It follows, with a certain irony, that the signals will ‘work’ most satisfactorily in the early and middle phases of a price trend, where its rationale is still entirely or largely intact, but where it is also less ‘obvious’ and where the signals appear to be relatively vague and premature.”