“Stick to the fundamentals. That’s how IBM and Hilton were built.”
– Lou Mannheim, Wall Street
The quote above is one of the key takeaways from the 1987 hit movie Wall Street. Lou Mannheim implores his young brokers to stick to the fundamentals after they pitch him on a less than quality stock to make a quick buck.
That line came back to me with striking clarity in January 2023. It was the first night of the spring semester at Baruch College in New York City where I have been teaching the technical analysis class for the past four years. One of the students in the class told me that she was there to learn to trade because she “needed to make a lot of money fast.” To her disappointment, I let her know that she was in the wrong place.
My class is not about getting rich quick. It is not run with the same infomercial vibe that many charlatans and hucksters pitch on the internet. You know the ones, “see how I made 1,000% on this trade” or “move all your money now before it’s too late”.
In my class, I teach the basics of technical analysis, and while the 24/7 action in crypto markets affords the students a chance to practice what they are learning in real time (the class is given at night), they are probably not going to hit a homerun. Instead, by the end of the semester, they will be well on their way to passing level one of the Chartered Market Technician’s exams.
The class is rooted in what John Bollinger would call the “first principles” of technical analysis. I wrote about this for Potomac clients earlier this month after hearing John speak at the CMT Association’s annual symposium in New York City at the end of April. Simple concepts such as the fact that stock prices are set by supply and demand in the market. Notice, I said stock prices, not company values. The stock and the company are not the same thing. Another principle of technical analysis is that markets trend. This just makes sense. If there was not a trend, how would you make money?
I love teaching the class because it allows me another opportunity to “talk markets” with a group who is extremely engaged. The class is an elective at Baruch, the students choose to be there, and it is oversubscribed every semester.
However, there is another reason that I enjoy this role. It keeps me rooted in the fundamentals of technical analysis. It keeps me focused on the key driver of stock prices, supply and demand.
As a Chartered Market Technician, I am considered an expert in the subject. But as with anything else, once we find what works best for us, we tend to stick with it. Imagine my surprise when I was putting together a lecture on indicators and found myself pulling out the old books to make sure that I knew the material inside out and backward. If I am going to talk about Bollinger Bands, I am going to reread John’s book. In this way I remain a student as well.
This is very important because we are bombarded with news, data, and “analysis” daily. Much of it is a distraction. Being a student and a teacher is a constant reminder of what is important.
If prices are set by supply and demand in the market, anything that impacts supply and demand is important to test and follow. Additionally, this first principle can be used as a jumping off point for the exploration of other ideas.
- If there is more demand for stocks, we would expect to see more stocks going up than going down; market breadth.
- There are certain parts of the year or investment cycle when demand can be expected to increase; seasonality.
- There are exceptionally large market players who have a lot of information and capital who can exert a certain level of influence on supply/demand dynamics; the Fed.
All of these are concepts that we use as part of our risk management and investment process at Potomac. Additionally, John Bollinger’s work makes an appearance in our indicators and analysis. However, teaching opens the door to research opportunities that can be used to build or refine indicators which are rooted in the fundamental principle of supply and demand.
Here is an example. While preparing the lecture on Intermarket Analysis, I was rereading John Murphy’s work where I was reminded that in an inflationary environment, the correlation between stocks and bonds usually turns positive. Many of you who have been following us know that this was a big theme in 2022. A theme for which many investors were not prepared as they had been lulled by the inverse stock/bond correlation that had been in play since roughly 1998-2000. As stocks moved lower, these investors were perplexed by the fact that bonds were also moving lower, failing to provide the diversification benefits that they had been dutifully supplying for more than two decades. They did not see that rising inflation altered the supply/demand picture for the so-called defensive asset.
From there it became easy to see that other first principle, markets trend. In this case, by end of the first quarter 2022, the trend in treasuries was clearly down. Preparing for that lecture forced me to be a student of the past and allowed me to see what was likely to unfold.
Teaching the technical analysis class has not only allowed me to share my knowledge but has also served as a constant reminder of the importance of sticking to the fundamentals. By focusing on the key driver of stock prices—supply and demand—and embracing the principles of technical analysis, we can try to navigate the market with a clearer perspective.
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