How do you find the right stocks to buy or sell in an uncertain market? We show you how with PriceActionSwing.
This week we take a brief look at some key markets from around the world, before going through a stock that has achieved 10% growth in the past 3 weeks, using Price Action Swing.
When we get to the bottom of the market, people start asking the same question – which stocks do I choose to get on board with?
In this video, we look at reliable method of choosing the best stocks going, when the market does eventually turn.
The Dow has topped and fallen from 18,500 to 15,500. That’s nearly 20% in just a few weeks.
Should we expect more, or is that it for now? Join us as we put together a mini-forecast of where the Dow might be headed over the coming months.
Master Trader Frank Tubbs
Frank Tubbs was a well-known analyst and trader in the 1930s. It was around this time he published his highly respected Tubbs’ Stock Market Correspondence Lessons. He remains one of my favourite analysts of all time, and I have his original writings which are very rare.
Tubbs was not as well known as W. D. Gann, Charles Dow or Jesse Livermore, however his works remain of great value to this day. These are the headings of his main body of work:
– Trend of the Market.
– Groups – Aggregates and Individuals.
– Records. Recording. Weeklies.
– Bases. Heads. Progressions. Swing Rule.
– Manipulation, Pools (Sponsor and Active). The Public.
– Selection of Trading Stocks. Making Trading a Business.
– Resistance and Support Lines.
– Investments. Long Move and Fluctuation Trading. Proportion.
– Mergers. Action of New Listings.
– Methods. Weekly Record Plan. New Highs and New Lows.
– Ideals, Personal Efficiency.
– Tape Reading.
– Technical Position. Accumulation, Progression and Distribution.
Tubbs’ “Stock Market Correspondence Lessons” is an extensive course and would be of benefit to any stock market trader. The earlier lessons cover the basics of successful trading – trend, aggregates (indices), record keeping and charting. The lessons progress with a discussion of his famous Swing Rule, Stock Selection, Support and Resistance Lines, his Law of Proportion and Technical Position.
When one studies the course, one must bear in mind that the course was written prior to the regulation imposed on United States’ markets after the 1929 stock market crash and subsequent depression. Lesson Six, ‘Manipulation, Pools (Sponsor and Active). The Public’ is a lesson which has little relevance in today’s regulatory environment. Nevertheless, it helps us to gain an understanding of the wild stock market trading days of the roaring twenties.
The course has a number of highlights, including his Swing Rule and his Law of Proportion. Its one lowlight, ‘Scale Trading’, shows that even a market master like Frank Tubbs could be influenced by the greed that permeated the great bull market of the 1920s and the fact that, at the time, few people could imagine it ending.
In Lesson 12, Tubbs advocates buying on a ‘scale down’. He illustrates the technique as follows:
In the rough, that this method may be understood in its idea, we will suppose that a stock is bought at 60 and instead of going upward it goes downward to 55. That gives one opportunity to buy again at 55, which is 5 points below first purchase, or on a 5-point scale. Supposing it then recedes to 50. Again opportunity is given for buying 5 points cheaper than the other purchase, and we are still on the 5-point scale; so the movement might go to 40 or 35 or 30 and each depression of 5 points would be opportunity to buy again
(Tubbs, F., Tubbs’ Stock Market Correspondence Lessons, page 146.)
Sadly, this technique can be a recipe for disaster.
In theory, this technique can lead to good profits. When it fails, however, the losses can be enormous. The technique assumes that good stocks will always recover. Many do – but it is the few that do not that can decimate a trading account. We can all think of classic examples!
Although advocated by some prominent traders in the booming 1920s, both W. D. Gann and Jesse Livermore condemned buying on a scale down, or ‘averaging down’ as it is called today. Both stated that it was one of the greatest mistakes a trader could make – and they were correct!
The Swing Rule
One of Tubbs’ major contributions to technical analysis was his swing rule. It is used in markets that make a high above an upward movement, or a low below the low of a downward movement.
Tubbs’ Swing Rule states:
When an aggregate group [Index] or an individual stock passes above previous high of movement (realize what a movement is) it is due to swing as much above that former high as it has since been below it.
(Tubbs, F., Tubbs’ Stock Market Correspondence Lessons, page 55.)
On the downside of the market the Swing Rule states:
When an aggregate group or individual stock passes below a previous low of movement it is due to swing as much below that former low as it has since been above it.
(Tubbs, F., Tubbs’ Stock Market Correspondence Lessons, page 55.)
Put simply, when a market crosses a previous top, expect that market to move upwards as far above the previous top as it had retraced below it.
The above chart of the Dow Jones in 2012, illustrates the swing rule in action. The rule is an excellent guide to what a market should do. A strong market will exceed the target price; a weak market will fail to reach the target price. In this instance, the Dow retraces almost 1640 points over several months, and then moves 1640 points above the last high, before retracing again. The market is in exact proportion!
Similarly, on the downside, when a market crosses a previous bottom, expect that market to move downwards as far below the previous bottom as it had rallied above it.
Although Tubbs’ course was a stock market course, his Swing Rule applies equally well to stocks, indices and futures markets.
Tubbs’ Law of Proportion
Frank Tubbs is probably best known for his Law of Proportion.
The Law of Proportion states:
Aggregates and individual stocks tend to move one half, two thirds and three fourths of previous moves. First in relation to the next preceding move which was made; then with relation to the move preceding that, which was made, it might go on indefinitely to the highest and the lowest at which price that stock or aggregate has ever sold.
(Tubbs, F., Tubbs’ Stock Market Correspondence Lessons, page 96.)
Tubbs’ Law of Proportion is consistent with Gann’s method of calculating support and resistance points. Gann’s instructions for finding support and resistance levels based on ranges are as follows:
12 1/2 OR 1/8: Take the extreme low and the extreme high of any important move. Subtract the low from the high to get the range. Then divide the range of fluctuations by 8 to get the 1/8 points, or 12%, 25% etc. which are resistance levels of buying and selling points 33 1/3% AND 66 2/3% OR 1/3 AND 2/3 POINTS: After dividing a commodity by 8 to get the 1/8 points, the next important thing to do is to divide the range of fluctuation by 3 to get 1/3 and 2/3 points. These 1/3 and 2/3 points are very strong, especially if they fall near other Resistance Points of previous moves or when they are divisions of a very wide range. The 1/3 point equals 33 1/3 percent, and 2/3 equals 66 2/3 percent.
(Gann, W., How to Make Profits in Commodities, page 34.)
Gann also used the same principle to calculate support and resistance levels from significant market highs and lows.
Tubbs’ Stock Market Correspondence Lessons are lessons that were first documented some 70 years ago. Despite the passage of time, the vast majority of these lessons are as valuable today as they were when they were first written.
The book Tubbs’ Stock Market Correspondence Lessons is presently out of print. It was published by McGraw-Hill Bookstore and sold for US$49.95. Amazon.com (www.amazon.com) has also sold the book.
The Dow Theory is the best known method of determining the major trends in the stock market. It also determines the type of trend, such as bull or bear.
Dow Theory is an excellent tool for use by long-term investors. Martin Pring illustrated its usefulness more than two decades ago:
Starting in 1897, an investor who purchased the stocks in the Dow Jones Industrial Average (DJIA) following each Dow theory buy signal, liquidated the position on sell signals, and reinvested the money at the next buy signal, would have seen the original investment of $44 in 1897 grow to about $51,268 by January 1990. If instead the investor had held on to the original $44 investment throughout this period, the investment would also have grown, but only to about $2,500.
[Pring, M. J., Technical Analysis Explained, McGraw-Hill, New York, 1991, p.31.]
Pring goes on to point out that even after transaction costs and taxes, the results would be far superior to a buy-and-hold strategy. Of course, given the bull market that followed 1991, the statistics would have been even more impressive.
Charles Dow was the son of a farmer. He was born in Sterling, Connecticut, in 1851.
His father died when he was six. He never finished high school, having to work as a labourer to help support his family.
In later life Dow became a journalist. It is believed he started his journalism career covering the city beat for the Springfield Daily Republican in 1872. He subsequently worked for other papers, including a position in 1879 reporting on a mining boom in Leadville, Colorado.
In 1880 Dow became a reporter in New York City, and later accepted a position with the Kiernan News Agency. A colleague at the News Agency was Edward Jones.
Dow and Jones resigned their positions at the Kiernan News Agency and formed Dow Jones and Company, with Charles Bergstresser, in 1882. Jones left the company in 1899.
In 1883 Dow and Jones and Company commenced printing a daily newsletter, the Customer’s Afternoon Letter. This two-page publication was considered very radical at the time. It published stock prices and company balance sheet information that previously had only been available to ‘insiders’. It was not until 1934 that the Securities Act required companies to file quarterly and annual reports in order to keep the investing public informed.
Dow Jones and Company published the first index that was designed to be representative of the movements of the stocks on the Wall Street stock exchange. This was called the Dow Jones Index.
The Customer’s Afternoon Letter became The Wall Street Journal in 1889, the United States’ best-known financial news service at that time. Dow was its first editor and remained editor until his death in 1902.
Dow was a member of the New York Stock Exchange from December 1885 to April 1891.
The Dow Indices
The first index, the Dow Jones Index created in 1884, contained eleven stocks. These included railroad stocks (nine), a communications company and a steamship company. The stocks were chosen because they were key growth stocks. The stocks were Chicago & North Western, D. L. & W., Lake Shore, New York Central, St. Paul, Northern Pacific pfd, Union Pacific, Missouri Pacific, Louisville & Nashville, Pacific Mail (steamship), Western Union (communications).
In 1896 Dow removed the railroad stocks from the Index and created two separate averages – the Dow Jones Industrial Average (DJIA) and the Dow Jones Railroad Average. The Dow Jones Railroad Average became the Dow Jones Transportation Average (DJTA), after the addition of air and truck transport stocks in 1970.
The Dow Jones Utilities Average (DJUA) was first compiled in 1929.
The Dow Jones Industrial Average commenced with 12 stocks in 1886. It was expanded to 20 stocks in 1916 and to 30 stocks in 1928. Today the Dow Jones Industrial Average contains 30 stocks, the Dow Jones Transportation Average contains 20, and the Dow Jones Utility Average 15. General Electric is the only stock of the original 12 to survive until today, despite being removed and replaced twice.
The Dow Jones Index was a simple average – calculated by adding the price of the eleven stocks together, and dividing the total by eleven. After 1928, the calculation became more complicated with the use of the ‘Dow Divisor’, a number that takes into account stock splits. Norman Fosback explains its use as follows:
Assume that the prices of the 30 stocks summed to $3,000. Then the 30-stock average would be $3,000 divided by 30, or 100.00. If one of the 30 stocks was quoted at $200, but then split two-for-one so that its price fell to $100, the sum of the prices would be only $2,900. To maintain the Average at its actual level of 100.00, the divisor of the average is systematically altered. Since $2,900 divided by 100.00 equals 29, the new divisor is set at 29, down from 30, in effect preserving the average price at $100 ($2,900 divided by 29 still equals 100.00).
[Fosback, N., Stock Market Logic, IER, Fort Lauderdale, 1986.]
As of August 17, 2001, the divisor values of the DJIA, DJTA and DJUA stood at 0.14452124, 0.20545179 and 1.6041980, respectively.
The Development of Dow Theory
William Peter Hamilton was a reporter who worked closely with Dow. He edited The Wall Street Journal until his death in 1929. Around the 1900s, people tended to assume that a stock’s price fluctuated in accordance with the specific fundamentals of the stock itself and the attitude of the traders who traded the stock. This was, and is, a reasonable assumption.
Between 1900 and 1902, Dow noted in The Wall Street Journal editorials the fact that although each stock moved independently, there was also an underlying trend of the market as a whole. Dow wrote very little about his theories and did not attempt to use his knowledge of his theory to publish market forecasts in his editorials.
In 1902 Dow’s friend, S. A. Nelson, wrote The ABC of Stock Speculation. Nelson’s book was the first explanation of the potential application of Dow’s theories.
Hamilton, an Englishman by birth, as editor of The Wall Street Journal, published editorials that he called ‘The Price Movement’. He believed that the stock market was an indictor of the profitability of business, which in turn could be used to forecast its own likely trend.
Between 1902 and 1929, Hamilton improved Dow’s methods. His accurate editorial forecasts in The Wall Street Journal established the value of Dow Theory, as it had become known, in forecasting stock market price movements and business trends.
In 1922, Hamilton published The Stock Market Barometer: A Study of its Forecast Value Based on Charles H. Dow’s Theory of the Price Movement. This classic book expanded on what Hamilton had written in his editorials. Hamilton died in 1929.
In 1932, Robert Rhea wrote his classic, The Dow Theory, based on his study and synthesis of the 252 editorials written by Dow and Hamilton. This book has a 139-page Appendix, in which the editorials of William Hamilton are reproduced.
What is Dow Theory
Dow Theory is based on the assumption that the averages discount everything. As Robert Rhea explains:
The fluctuations of the daily closing prices of the Dow-Jones rail and industrial averages afford a composite index of all hopes, disappointments and knowledge of everyone who knows anything of financial matters, and for that reason the effects of coming events (excluding acts of God) are always properly anticipated in their movement. The averages quickly appraise such calamities as fires and earthquakes.
[Rhea, R., The Dow Theory, Barron’s, New York, 1932, p19.]
Dow Theory considers that market movements can be described in terms of the primary trend (the bull and bear markets which are measured in years), the secondary movements (which are measured in weeks to months) and daily fluctuations, which are of little significance. Secondary movements correct moves in the primary trend.
Dow also addressed the issue of market phases in primary bull and bear markets. He divided a primary bull market into three phases:
A primary bull market is a broad upward movement, interrupted by secondary reactions, and averaging longer than two years. During this time stock prices advance because of a demand created by both investment and speculative buying caused by improving business conditions and increased speculative activity. There are three phases of a bull period: the first is represented by reviving confidence in the future of business; the second is the response of stock prices to the known improvement in corporation earnings, and the third is the period when speculation is rampant and inflation apparent – a period when stocks are advanced on hopes and expectations.
[Rhea, R., The Dow Theory, Barron’s, New York, 1932, p13.]
He also divided a primary bear market into three phases:
A primary bear market is the long downward movement interrupted by important rallies. It is caused by various economic ills and does not terminate until stock prices have thoroughly discounted the worst that is apt to occur. There are three principle phases of a bear market: the first represents the abandonment of the hopes upon which stocks were purchased at inflated prices; the second reflects selling due to decreased business and earnings, and the third is caused by distress selling of sound securities, regardless of their value, by those who must find a cash market for at least a portion of their assets.
[Rhea, R., The Dow Theory, Barron’s, New York, 1932, p13.]
According to Dow Theory, a bull trend is defined as a series of higher peaks and higher troughs. A bear trend is defined as a series of lower peaks and lower troughs. For Dow Theory to confirm a bull market, both the Dow Jones Industrial Average and the Dow Jones Transportation Average must be in bull trends. For Dow Theory to confirm a bear market, both the Dow Jones Industrial Average and the Dow Jones Transportation Average must be in bear trends. The closer these confirmations occur in time, the more significant the resulting move is likely to be.
Dow Theory also discusses accumulation and distribution. If a market moves within a range of about 5 per cent for several weeks or more, accumulation or distribution is taking place. If both averages subsequently break out above this ‘line’, the sideways movement was accumulation and prices should continue to rise. If both averages subsequently break out below this ‘line’, the sideways movement was distribution, and prices should continue to fall. A break by only one average is inconclusive.
If you don’t know, George Soros ranks as one of the all time great hedge fund managers. This year, the Soros fund achieved a 25% return on $25 billion funds under management and achieved the #1 spot of Hedge Funds in 2013*. In his best year, Soros and James Rogers under the Quantum Fund, achieved 423% return in a single year, before Rogers retired at the ripe age of 37, a multi-millionaire.
The Australian recently printed a headline that our debt really was one of the highest in the world, higher in fact than 17 other countries*. These ‘rich’ countries include Sweden, the US, France and even our cousins across the pond, New Zealand. It was reported that since the GFC, our debt burden has tripled, compared to most other countries that have less than doubled. Without getting at all political, debt rose by some $667 billion under the Rudd/Gillard years, but, is that any need for panic? Who do we trust when we read something like that? What sort of influence should it have?
Add to such headlines the myriad of bank reports that we receive, from banks domiciled here and overseas (most of whom report different forecasts) and you wonder what to believe. Once you can get through the myriad of graphs, tables and data there is just a few lines at the bottom dedicated to what any economist really thinks is going to happen. You can see some of the bank reports we receive on our Home Page.
For example, some pick interest rates as likely to stay stable, others as likely to move up…before moving down again, while others pick further cuts. The RBA is often no different, possibly due, like the Fed in the US, to its vested interest. Banks business is lending money, hence why the Fed is so insistent on pumping trillions into the US economy; drying up demand or supply will cripple banks, who believe that the world simply could not survive without their influence on the worlds credit supply. Newspapers certainly have their biases as well, though in the case here, it is fairly factual – Australia has high debt.
Who do you believe with all of this?
Much of our business is based on understanding market fundamentals, in particular interest rates and money supply, all of which affect either positively or negatively, currency and market movements. We use a mix of both fundamental and technical analysis in our trading. Contrary to so many in the business, we don’t simply put a few squiggly lines on charts and buy when it’s above, and sell when it’s below. So, how do we decide what to listen to?
Like everyone, we have our favourites. In fact in some instances we actively trade against one particular bank forecast, with considerable success too! Usually though, we read a lot and get a picture of the themes we think are important at the time. Consider the example of housing for the moment; our sentiment is that housing is most often driven by confidence in a market. When people are confident about their job, their security, their business – basically their income, they will be ready to invest into housing. There are one or two ‘confidence indexes’ around that we watch carefully, as confidence affects many different things in business, not just housing.
We also look at past experience: again, using the example of housing, when I grew up in London, banks had a standard of lending 3x a person’s income, and it rarely fluctuated. During the ‘90s that changed, and banks began to lend 3.5x, then 4x and finally, they would lend 5x a person’s income. When you are leveraged that highly in any market, any slight change in conditions has the potential to significantly change the outcome. It did, and in the early ‘90s there was a property collapse of such proportions, that nearly 75% of all homeowners in the UK had negative equity in their homes. It was something that was supposed to never be able to happen.
So, we look for similar things that are happening now. Not just in housing by the way, but in every area of the economy, and certainly high debt is one of them. It’s not so much the debt, but the fact that both Federal and State seems to be in debt, and the debt has risen with such speed over the past few years. Debt has to be paid for by a country, just as it does with us.
When our credit cards are too high, we have to divert spending away from other things to meet our debt obligations. Well, countries have to do the same. Don’t they…? Well, actually yes, they do. Spending cannot go on forever. Just look at what happened to Detroit, after four decades of out of control spending by successive governments, as in the comment from an article below:
Its residents also bear a bigger tax burden as a percentage of income than those in other large U.S. cities even as the city struggles to stay fiscally afloat.
“They get a lot of money on a per capita basis. They just can’t control their spending,” said Bettie Buss, the council’s senior research associate and the report’s author.**
It’s not exactly where Australia would like to end up. But coming back to the original point of this, who can you trust if you are looking for information to base your decisions on? Well, it’s not always black and white, especially with so many vested interests (incl the Governments) in the market. We speak to many seasoned investors, and one of the factors that come into play is their own hunch. After years of dealing in a particular market, many good investors develop a sixth sense into where a market may be headed, and with their years of experience, they may be the most accurate.
Certainly we rely on this to some degree in our own trading. When we look at charts for hours every day, we get a good feeling for where a market is going. Is that enough on its own though? No.
Our suggestion is to read as much as you can at this stage, until you begin to find out what you like and what you don’t like. Some reports, newspapers, websites, journals etc gel with you, others you will reject. Combine this with good technical analysis, and you will be on the way to making some strong financial decisions.
But, here is the last thing, and possibly the most important. When we’re long in a market (that means we’ve bought it) we will look for every indication that tells us we are right. The overriding factor we need to consider though is what happens if I am wrong? In our opinion, it is what sorts out the professionals from the amateurs. Much of what we do is based on our forecasting, but we never get so hung up on our forecasts that we can’t be wrong. In fact, we are often wrong. Forecasting on its own never made anyone any money. Only the ability to act on your forecasts did.
The number of people we speak to who are wrong in a market, and refuse to get out, but instead cling onto their own pride that they just cannot be wrong. It’s inevitable what happens. So, interpretation of what you see, as well as your ability to act both when you are right and wrong is what makes an excellent trader or investor. That goes for any market, not just ours.
Reading, fundamentals, and gathering of good information is vital, but other factors; our instinct, our interpretation is just as important. But none of it is as important as being able to put aside the emotions, and act on what is before us.
For a useful bank report on the current state of the economy, try Westpac’s here. http://www.westpac.com.au/about-westpac/media/reports/australian-economic-reports/
Bear in mind that Westpac is one of the major mortgage lenders in the country, and so their forecasts tend to support their own business view.
We also load bank reports of interest up on our website as we find them; some are more technical than others, particularly in the area of currency and derivative products.
* The Australian, 17 May http://www.theaustralian.com.au/national-affairs/in-truth-our-debt-growth-faster-than-europes/story-fn59niix-1226920839651#