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MANAGING VERSUS FORECASTING
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I once ran into a very fat surgeon at a seminar. He told me that he had lost a quarter of a million dollars in three years trading stocks and options. When I asked him how he made his trading decisions, he sheepishly pointed to his ample gut. He gambled on hunches and used his professional income to support his habit. There are two alternatives to "gut feel": One is fundamental analysis; the other is technical analysis.

Major bull and bear markets result from fundamental changes in supply and demand. Fundamental analysts follow crop reports, study the actions of the Federal Reserve, track industry utilization rates, and so on. Even if you know those factors, you can lose money trading if you are out of touch with intermediate- and short-term trends. They depend on the crowd's emotions.

Technical analysts believe that prices reflect everything known about the market, including all fundamental factors. Each price represents the consensus of value of all market participants — large commercial interests and small speculators, fundamental researchers, technicians, and gamblers.

Technical analysis is a study of mass psychology. It is partly a science and partly an art. Technicians use many scientific methods, including mathematical concepts of game theory, probabilities, and so on. Many technicians use computers to track sophisticated indicators.

Technical analysis is also an art. The bars on a chart coalesce into patterns and formations. When prices and indicators move, they produce a sense of flow and rhythm, a feeling of tension and beauty that helps you sense what is happening and how to trade.

Individual behavior is complex, diverse, and difficult to predict. Group behavior is primitive. Technicians study the behavior patterns of market crowds. They trade when they recognize a pattern that preceded past market moves.

Poll-Taking

Political poll-taking is a good model of technical analysis. Technicians and polltakers try to read the mass mind. Polltakers do it for political gain, technicians for financial gain. Politicians want to know their chances of being elected or re-elected. They make promises to constituents and then ask poll­takers about their odds of winning.

Polltakers use scientific methods: statistics, sampling procedures, and so on. They also need a flair for interviewing and phrasing questions; they have to be plugged into the emotional undercurrents of their party. Poll-taking is a combination of science and art. If a polltaker says he is a scientist, ask him why every major political polltaker in the United States is affiliated with either the Democratic or Republican party. True science knows no party.

A market technician must rise above party affiliation. Be neither a bull nor a bear, but only seek the truth. A biased bull looks at a chart and says, "Where can I buy?" A biased bear looks at the same chart and tries to find where he can go short. A top-flight analyst is free of bullish or bearish bias.

There is a trick to help you detect your bias. If you want to buy, turn your chart upside down and see whether it looks like a sell. If it still looks like a buy after you flip it, then you have to work on getting a bullish bias out of your system. If both charts look like a sell, then you have to work on purging a bearish bias.

A Crystal Ball

Most traders take price swings personally. They feel very proud when they make money and love to talk about their profits. When a trade goes against them they feel like punished children and try to keep their losses secret. You can read traders' emotions on their faces.

Many traders believe that the aim of a market analyst is to forecast future prices. The amateurs in most fields ask for forecasts, while professionals simply manage information and make decisions based on probabilities. Take medicine, for example. A patient is brought to an emergency room with a knife sticking out of his chest—and the anxious family members have only two questions: "Will he survive?" and "when can he go home?" They ask the doctor for a forecast.

time to recover. Prices seldom rally very hard immediately after a bad decline.

Successful trading stands on three pillars. You need to analyze the balance of power between bulls and bears. You need to practice good money management. You need personal discipline to follow your trading plan and avoid getting high in the markets.

But the doctor is not forecasting — he is taking care of problems as they emerge. His first job is to prevent the patient from dying from shock, and so he gives him pain-killers and starts an intravenous drip to replace lost blood. Then he removes the knife and sutures damaged organs. After that, he has to watch against infection. He monitors the trend of a patient's health and takes measures to prevent complications. He is managing —not fore­casting. When a family begs for a forecast, he may give it to them, but its practical value is low.

To make money trading, you do not need to forecast the future. You have to extract information from the market and find out whether bulls or bears are in control. You need to measure the strength of the dominant market group and decide how likely the current trend is to continue. You need to practice conservative money management aimed at long-term survival and profit accumulation. You must observe how your mind works and avoid slip­ping into greed or fear. A trader who does all of this will succeed more than any forecaster.

Read the Market, Manage Yourself

A tremendous volume of information pours out of the markets during trading hours. Changes in prices tell us about the battles of bulls and bears. Your job is to analyze this information and bet on the dominant market group.

Dramatic forecasts are a marketing gimmick. People who sell advisory services or raise money know that good calls attract paying customers, while bad calls are quickly forgotten. My phone rang while I was writing this chapter. One of the famous gurus, currently down on his luck, told me that he identified a "once-in-a-lifetime buying opportunity" in a certain agricultural market. He asked me to raise money for him and promised to multiply it a hundredfold in six months! I do not know how many fools he hooked, but dramatic forecasts have always been good for fleecing the public.

Use your common sense when you analyze markets. When some new development puzzles you, compare it to life outside the markets. For example, indicators may give you buy signals in two markets. Should you buy the market that declined a lot before the buy signal or the one that declined a little? Compare this to what happens to a man after a fall. If he falls down a flight of stairs, he may dust himself off and run up again. But if he falls out of a third story window, he's not going to run anytime soon

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