Professional Documents
Culture Documents
Summer
2001
In this issue
FEATURED ARTICLES
Letter from the President, 1
The Rules of 3: Risk Control
and Money Management
The Wyckoff Way, 3
Men and Women Trade
Differently, 6
EDUCATION
CMT I Now Available Through
FI 352 at GGU, 9
RAVE REVIEWS
Irrational Exuberance, 10
Page 2
Included in your ticket price will be a deli luncheon buffet available on your
arrival, and in the evening hors doeuvres will be served. There will also be a nohost cocktail hour to help you celebrate your best fish stories or to help you drown
your sorrows and woulda-coulda-shouldas.
In addition to our seminar, the TSAA, as a nonprofit technical analysts and
traders organization, seeks to offer aide, support and guidance to individual
traders and financial professionals. We do this through:
Teaching classes at Golden Gate University.
Presenting knowledgeable and accomplished speakers at monthly meetings.
Publishing a quarterly newsletter filled with insightful articles and information
useful to technicians and traders.
Offering a substantial library of books on technical analysis available to our
members at GGU.
Providing a web site which serves as a bulletin board for organizational activities
and as a resource for items of interest to technical analysts and traders.
As a nonprofit organization of investment professionals and individual traders,
our members share their special knowledge and talents with other members and in
so doing, enhance and refine their analytical talents and move ever closer to their
own market mastery.
The TSAA seeks input and involvement from individual traders, and from professionals accomplished in technical analysis. Whether you wish to further your
financial career or move closer to your own mastery of the markets, I believe you
will be enriched through your involvement with the TSAA.
For more information about the TSAA and what we offer, visit our web site at
www.tsaasf.org. If you have questions, suggestions or information that you believe
might be of value to our members, please email our staff@tsaasf.org.
If you would like to explore opportunities within the TSAA, feel free to email
me at president@tsaasf.org.
Page 3
FEATURED ARTICLES
The Rules of 3:
3
Risk Control and Money Management
The Wyckoff Way
By Henry O. (Hank) Pruden, Ph.D., Golden Gate University
TSAA Review
The TSAA Review is a quarterly periodical published by
and for members of the
Technical Securities Analysts
Association of San Francisco.
Its purpose is to facilitate
communication of informative
and useful information to
members. Articles of interest
to members are welcome and
are subject to acceptance
after editorial review. All articles are the viewpoint and the
sole responsibility of the
author. Publication of an article does not necessarily reflect
the opinions of the TSAA.
All copy for publication
should be submitted to Editor,
TSAA Review, via email at the
addresses below.
Henry O. Pruden, Co-Editor
Golden Gate University
hpruden@ggu.edu
Page 4
portfolio and initiate the order to exit the market. These active money management
approaches were spelled out under the headings of Exit Strategy 1 and Exit
Strategy 2 which will appear in the ATAA Journal (July-August 2001).
The 3-1 Rule and the 1/3, 1/3, 1/3 Rule inform the Wyckoff oriented trader or
investor about how to approach entering a position. Applying these rules requires
active participation by the trader or investor.
The Rules of 3
Two critical ratios revolve around the use of the number 3: these are the 3-1
Reward to Risk Rule and the 1/3, 1/3, 1/3 Commitment of Capital Rule. One Rule
of 3 is the 3-1 Rule designed for controlling risk. The ratio measures a reward-torisk threshold that must be met before any capital can be invested in a stock. The
reward numerator part of the ratio is calculated by measuring the extent of the
potential built up in a base of accumulation. According to the Wyckoff Method this
measurement of potential is best done with a point-and-figure chart. The risk
denominator in the 3-1 Reward to Risk Rule ratio is measured by the distance
between the entry price and the proposed stop-out exit price. Hence, a base count of
30 points could justify a stop order10 points away from entry. Over repeated trials a
ratio of less than 3-1 was observed by Wyckoff and his associates as being too risky.
The other Rule of 3 is the 1/3, 1/3, 1/3 Rule for money management. This is a
rule for allocating capital in tranches. When a desirable 3-1 Reward to Risk ratio
has been identified, the trader should commit 1/3 of her/his available capital in a
first purchase. Consequently, should this initial position be stopped out, the expected loss would be minimized. The stop-loss would limit the loss and the capital risk
exposure would truncate the loss because no more than 1/3 of capital would have
been exposed.
If and when the first 1/3 of capital committed showed a profit and another
Wyckoff buying juncture appeared, then a second 1/3 of capital could be invested.
Concurrently the initial stop order would be raised to the level of the stop on the
second position so that the total risk exposure on two-thirds capital would not be
much more than the risk exposure that existed on the original one-third investment.
After the first two positions had shown a profit, the third and final position
could be added and the stop on the first two positions raised to a high enough level
that even if the total position were stopped out a profit would still result.
Afterward, as the trend evolved stops would be adjusted upward (downward)
behind the entire 3/3 position.
Active monitoring of the position would be required by the trader. A rhythm of
detached overview-monitoring to allow the trend to run its course should alternate
with more intense detailed-monitoring as the trader periodically zoomed in to look
more closely at the market for an appraisal of the quality of the trend.
Finally, the Wyckoff Method calls for active money management by the
trader/investor as signals to take profits or abort a losing position occur (Exit
Strategies 1 and 2). A passive stop-loss strategy always exists as a backup (Exit
Strategy 3). But as a priority under the Wyckoff Method, the investor or trader is
responsible for actively executing orders to take profits or cut losses.
Page 5
30% loss as opposed to the 80% loss that his portfolio had suffered by April 2001.
These stop-out risk control steps, which would have protected Mayor Brown, utilizes only the passive, fall-back money management methods available through
with the Wyckoff Way.
A good illustration of the 3-to-1 Reward to Risk Ratio Rule in operation was
presented in the Spring-Summer 2001 issue of the MTA Journal. One of the classic
nine buying tests of the Wyckoff Method is Estimated upside profit potential is at
least three times the loss if protective stop is hit. Thus risk control via the 3-1
Rule is built into the basic Wyckoff decision checklist. However, the money management angle of the 1/3, 1/3, 1/3 Rule for investing capital, subsequently developed by Mr. Robert G. Evans of Wyckoff Associates did not become part of the 9
Wyckoff Tests. Since this Rule of 3 was not made part of the classic Wyckoff
Tests, it was not used by the Wyckoff-oriented trader operating in the SF Company
case at the time of the case study. Nonetheless, we can return to the SF Company
case to illustrate how the 1/3, 1/3, 1/3 Rule for money management could have
been employed for the SF Company. Charts 1 and 2 if the San Francisco Company
are reprinted and attached to this article for your convenience, in showing the
Rules of 3 in operation.
According to the case study, point 16 was a legitimate backup which followed
a sign-of-strength jump to point 15. Hence 16 was a juncture at which an initial
1/3 of the capital earmarked for the SF Company could
have been invested (1/3, 1/3, 1/3 Rule). Also the figure
chart count at 10 was large enough to exceed the stop-loss
risk by more than the required minimum of 3-1, thus an
example of the 3-1 Rule.
Following the successful further advance to point 17,
another 1/3 of capital could have been committed at point
18, with the protective stop order on both this purchase
and the initial purchase raised to slightly under point 16.
The final one-third of capital could have been invested
upon the completion of either of two subsequent re-accumulation formations. As noted in the case, Point 20 was a
less convincing juncture than point 31. Nevertheless, had
the final 1/3 of capital been invested on the basis of the
spring action the trader observed at Point 20, a floating
or open air stop could have been placed around $26.00 on
all three positions. Such a stop placement would have
adhered to the 3-1 Reward to Risk Rule. However, setting a stop at $26 would
have gone against the risk-control rule of Wyckoff which calls for setting stops
below prior support levels.
Alternatively, the final one-third of capital could have been invested after the
passage of all nine of the new re-accumulation tests at Point 31 with the stops for
all 3/3 of the position set around $30 or $31. All of the
preceding active money management steps would have
required judgment and emotional discipline by the trader.
But the availability of the 3-1 Rule of Wyckoff and the
1/3, 1/3, 1/3 Rule of Wyckoff for risk control and money
management would have helped the trader to retain his
mental equilibrium while using his judgment to take
maximum advantage of the buying junctures, revealed to
him through the application of the Wyckoff Method. In
sum, the San Francisco Company case study illustrates
how the Wyckoff Rules of 3 operating together give the
trader an elementary yet sound start on the road to effective money management
and risk control.
Page 6
TSAA Officers
President
James J. Forte, CMT
Charles Schwab & Co., Inc.
Vice Presidents
Brent L. Leonard, CMT
Adjunct Professor
Golden Gate University
Marc Lichtenfeld
ON24
Sean Phelan
Headwaters Capital
Treasurer
Daniel K. Beatty
John W. Brooker & Company,
CPAs
Secretary
Audrey P. Lewak
Merrill Lynch
Membership
Henry O. Pruden
Golden Gate University
Newsletter
Michiel Hurley
SoundView Technology
Group
Brent L. Leonard
Golden Gate University
Henry O. Pruden
Golden Gate University
IFTA Representative
Gerald P. Butrimovitz
Gerald Butrimovitz and
Associates
Board Chairman
Robert L. Bergey
Investor
Up until the 1080s it was believed that males and females brains operated in
much the same way. Technological advances produced scanning techniques that
revealed significant physiological differences between the male and female brain.
Differences that are present from the time we are born. It is important to be aware
how this can enhance or detract from your performance as a trader.
Over-Trading
Using account data for over 35,000 households, Barer and Odean analysed the
common stock investments of men and women from February 1991 through
January 1997. Men traded 45% more but earned 1.4% per annum less in comparison to females. These differences are more pronounced between single men and single women. Single men traded 67% more than single women and earned 2.3% per
annum less.
Over-trading leads to underperformance. The 20% of investors who traded most
actively earned an average net annual return 5.5% lower than that of the least
active investors. In a study of 78,000 households, women turned over their portfolios about 53% annually and men turned their portfolios over 77% annually.
Chemistry
When a mans brain is in a resting state, 70% of its activity is shut down.
Continual brain stimulation is an uncomfortable state for a man. This implies that
men can mentally index their problems and put them on hold. To obtain peak effec-
Page 7
tiveness, guys need time to be master of the TV remote and become one with the
couch. Men; take a break from trading from time to time to give your brain a
chance to shut down. Youll trade much more effectively using this method, instead
of subjecting yourself to the constant stimulation of the sharemarket.
In a relaxed state, a womans brain still functions at 90% of its usual activity
level. This shows that women are more likely to be processing information continually. Females have difficulty putting their problems on hold and often need to talk
through a situation in order to find a solution. Female traders may have a greater
requirement to discuss their wins and losses with a friend.
Confidence in Decisions
About TSAA
As a nonprofit, independent
association, the Technical
Securities Analysts Association
of San Francisco is committed
to the principles of fellowship,
education, and development
of its members. TSAA believes
that individual growth and
excellence can best be created
in an environment of encouragement and support. As a
dynamic organization, the
Association embraces all concepts of technical market
analysis, encourages its members to pursue their own
unique approach to the market, and provides for the
exchange of ideas and
methodologies. TSAA provides
leadership opportunities and
educational pathways for the
beginning and advanced member alike to achieve effective
market mastery.
Reaction to Stress
Under pressure, women eat chocolate and go shopping. Upset women will talk
about their problems. This has the effect of allowing the physiological signs of
stress to dissipatepossibly partially explaining why, statistically, women outlive
men.
When dealing with a distressed woman, it is important to listen in order to validate her feelings. Offering solutions at this stage is not necessary or productive. If
you are the spouse of a female, please remember this.
When feeling stressed, men drink alcohol and invade other countries. They
react aggressively and are more likely to lash out. Negative emotions can be sublimated to reappear at a later datepossibly disguised as a heart attack. If you are
the spouse of a male trader, remember that men do not like unsolicited advice.
They need to feel that their spouse has confidence in their ability to sort out their
own problems.
Testosterone
There is a correlation between heightened testosterone levels and signs of
aggression. Professor James Dabbs of Georgia State University found that superior
achievers in any endeavour had higher testosterone levels than lower achievers.
The thrill of achievement actually causes more testosterone to be produced.
Based on these findings, high achieving males in the trading field, presumably,
have heightened testosterone levels. However, to maintain terrific results high
achievers probably need to find a way to alleviate their hostility. Its very difficult to
punch the living heck out of the sharemarket, so youll need to find another method
of dissipating your aggression levels. Physical exercise is a great alternative.
Taking revenge on your computer screen is not.
Page 8
Solution
Men
Over-trading
Over-Confidence
Aggression
Dont seek revenge if you have made a loss. Fight your battles with an opponent that you can make eye contact with.
Physical activity may assist. Following a written trading
plan will help you avoid taking unnecessary risks when
you feel like you could strut into a boxing ring like Rocky.
TSAA Membership
Membership in the TSAA is
open to individuals who are
interested in technical analysis as part of their investment
strategy. Annual dues provide
members with member-rate
admission to seminars, meetings, and luncheons as well as
a subscription to the TSAA
Review.
For membership information contact us at one of the
addresses below. Please
include your postal delivery
address, and our membership
information packet will be
mailed to you.
Technical Securities Analysts
Association
5 Third Street, Suite 724
San Francisco, CA 94103-3200
415-957-1202
Fax 415-543-2112
staff@tsaasf.org
Women
Lack of Confidence
Concerns that
investing/trading is
a male domain
Louise Bedford is a full-time private trader and author of The Secret of Writing Options and
The Secret of Candlestick Charting. This is an extract from her book Trading Secrets, due for
release in the second half of 2001. For information on her seminars and workshops, visit
www.tradingsecrets.com.au.
Page 9
EDUCATION
CMT I Now Available Through FI 352 at GGU
Frustrated by the stock market? Intrigued? Want to understand whats really
happening? Whether your goal is amateur investing or a professional career as a
broker, Golden Gate Universitys pioneering program in technical market analysis
(TMA) will give you important insights and tools. This fall, GGU offers two courses
taught by experts in the field.
The first course, FI 352 Technical Analysis of Securities, will be taught by Hank
Pruden, executive director of the Institute for Technical Market Analysis and director of GGUs TMA graduate certificate program. Students who take this course at
GGU will be eligible to take in class the first level of the three exams required to be
certified as a Chartered market Technician (CMT). The CMT is a professional designation, comparable to the CPA or the CFA. For the prospective student, the CMT
I Exam option is a very attractive feature, says Pruden. Students can kill two
birds with one stone, so to speak: for the same tuition to GGU, they can earn both
credit for the course and the option of completing their CMT I Exam requirements.
GGU is the only school in the Bay Area to offer this opportunity.
In the second course, FI 498 Online Investing, students will learn how to do
research and trading on the internet with one of the most well-known members of
GGUs outstanding adjunct faculty. Harvey Baraban, the Malcolm S.M. Watts III
Adjunct Professor, has been employed in every aspect of the securities business during his long career in the field. In the 1970s, Baraban formed Baraban Securities,
the largest independent broker dealer in California, which he sold a decade later.
Over the years, he has trained more than 30,000 people to be licensed as stockbrokers. Baraban appears regularly on local television and is widely quoted on the
financial pages of the San Jose Mercury News and the San Francisco Chronicle.
The bulk of the online investing course deals with pattern recognition and
fundamental technical tools, says Baraban. Students will learn where to find technical market analysis on the Internet and how to use it so they can develop an
investment or trading plan for themselves. Its a very topical course, because we
talk about what is currently affecting the market. Students will learn the various
aspects of the financial-services markets. The course will help them decide if they
want to be involved in working in the stock markets. The course will be taught in
the computer lab.
For further information on GGUs courses and graduate certificate in Technical
Market Analysis, contact Hank Pruden at 415-442-6583 or hpruden@ggu.edu.
FI 352TECHNICAL ANALYSIS OF SECURITIES
SF1-San Francisco 3 9/4-12/11 T(4:00-6:40) Pruden Materials fee: $20
Examines empirical evidence concerning non-efficient markets in which technical
analysis is thought to apply. Topics include trend analysis, turning-point analysis,
charting techniques, volume and open interest indicators, contrary opinion theories,
and technical theories such as Dow theory and Elliott waves. Prerequisites: FI 203
(or FI 100) or FI 300A.
FI 498AONLINE INVESTING: USING THE INTERNET FOR STOCK MARKET RESEARCH AND
INVESTING
SF1 San Francisco 3 9/5-12/12 W(4:00-6:40) Baraban Lab Required; Room 460 only
An intensive study of the rich variety of sources on the Internet that provide information to help the investor make appropriate stock selections, and the techniques
of day trading on the Internet. Prerequisite: FI 352.
For more information, visit www.ggu.org, or contact Hank Pruden at
hpruden@ggu.edu, 415-442-6583, or Tracy Weed at 415-442-6585.
Page 10
RAVE REVIEWS
Irrational Exuberance
By Robert Shiller; Professor, Yale University
March 2000, Princeton University PressISBN 0-691-05062-7
Synopsis by Brent L. Leonard, CMT
TSAA eGroup
You are invited to join this
TSAA-beta group, an email
group that is free and easy to
use. By joining this group,
youll be able to send messages easily to fellow group
members using just one email
address. eGroup also makes it
easy to store photos and files,
coordinate events and more.
To join, go to www.
egroups.com/invite/TSAA-beta
and click the Join button.
Well see you there!
One of the most current topics of Technical Analysis, both nationally and at
Golden Gate University, is the field of Behavioral Finance (Economics); and one of
the leading thinkers in that fieldalong with locals like Terence Odean, Richard
Thaler, Hersch Shefrin, et.al., is Robert Shiller, the author of the this book who
named it after Alan Greenspans 1996 utterance about the American stock market.
What is so prescient about the book is that it was actually written well before
the beginning of the recent Bear market, but anticipated it perfectly. He had a
paperback version of it come out last April in bookstores. What is also exceptional is
his extensive research as shown in copious notes at the end of the book. He, and
others he cites, have been doing questionnaire surveys for decades on investors
(both individual and institutional) opinions on various subjects that are taken for
granted, but not necessarily true.
One example of this is the commercial by Peter Lynch about stock prices
always following earnings in lockstep. In Shillers chart he shows the Prices of the
Dow Industrials rising from 3500 to 11,000 in 5 years, while earnings were only up
in the teens. Another meaningful chart shows the markets P/Es before and after
various Crashes:
Year
P/E
1901
1929
1966
2000
25
34
24
45
5
6
7-8
??
Addressing the Buy and Hold theory of always getting ones money back shortly
after a Crash, he cites Real (Inflation-adjusted) returns for time periods after 1929:
5-year, 1.3%; 10-year, 1.4%; 15-year, .5%; and 20-years, +.4%. About the same
for 1974 similar periods. His findings also show that after 44 P/Es, a scattergram
suggests negative real earnings for the next 10-year period; and periods of low
Dividend Yields (1.2%) always result in bad returns for the next few years.
He then proceeds to list the 12 reasons for the recent ballistic Bull market:
1. The Internet improving productivity, earnings.
2. Lack of global competition-our lock on technology allowed for massive exports
3. Baby Boomers, 1946-1966. Spending more and investing more through 401ks
4. Expanded media coverageCNN, CNBC, Internet sites, etc. TVs on at brokerages and other businesses.
5. Analysts optimism; Sell recommendations dropped from 9% to 1% from 1989 to
1999.
6. Beginning in 1981Defined Contribution replaced Defined Benefits, making
the individual responsible for the investment choice.
7. Explosive growth in number of mutual funds enticing investors with expert
management, low-risk and low-cost investing. Funds in 1982 numbered 340; in
1998 3513 (5300 today, added to closed-end and ETFs would number 8500,
per Barronsthats more than 3 funds for each listed stock). In the same timeframe, number of shareholders accounts grew from 6 million to 120 million, 2
per family.
8 Decline in Inflation2% growth in the CPI since 1982.
Page 11
Shiller then goes on to explain some of the Behavioral Finance terms, such as
non-linear feedback loops, selective listening (hearing only what agrees with your
position), amplification mechanisms 96% of people surveyed believe that stocks
always have the best overall return. Not so, according to Shillere.g., in the 70s it
was real estate. 91% somewhat agree that a market will rebound totally within 2
years, wile post-Crash declines (Nikkei, gold, 1929, Tulips) refute that.
Other BF principles include Psychological AnchorsQuantitative, such as how
Interview questions are frameddo you earn $30,000 or $40,000 a year, watch out
for 10,000 level on the Dow, etc. The other anchor is Moraldo I deserve to have
this much money, asks the Microsoft millionaire with Fantasy wealth on paper? If
they all believe, they may all sell, dropping their price and net worth.
Overconfidence and hindsight make great armchair quarterbacks out of investors.
(Whats Greenspan thinking?) As all good chess players do, investors should consider all possible outcomes and react accordingly, tactically and strategically.
One other principle is the Herd Instinct, or Epidemiczeitgeistwhich is partially caused by everyone listening to the same information sourceCNBC, WSJ,
et.al., at the same time. News that everyone knows is no longer news! Shiller cites
studies that show that people will react illogically to large groups or high authority
figures (knowingly giving a wrong answer to a question in order to conform). As an
example, they did studies where a person was put in a room with several persons
who intentionally gave wrong answers; the person was eventually persuaded to
agree with them on the wrong answer.
People tend to like storytelling in stock selectionthis company just invented
a new; studies show that most stock choices are made from person-to-person recommendations, face to face preferable, or phone conversations (cold calls); television
bridges the gap from the previous twoface to face but not interactive. Finally, contributing to our Bubblechat rooms, websites from experts, voice trading, e-mail,
all contributed to the seduction of the investor.
Lastly, Shiller relates some very interesting historical data going back to 1900,
and exhibits more numerical studies that explode a lot of myths that we take for
granted. He ends with some radical suggestions, like a transaction tax, proposed by
Larry Summers and fellow Prof. James Tobin, to curb speculation. Abolish trading
curbsour worst Crashes occurred on Monday, after a long weekend. Shiller also
advocates Macro Marketssecurities to hedge real estate (ones own home), even
claims on income flows.
Altogether a very worthwhile read, lots of facts and studies, and a good look
into Behavioral Finance.