Technical Analysis Case Study: Trader Buys Baseball's Red Sox...Who Says You Can't Get Rich Trading?

by Dr. Steve Sjuggerud

Technical Analysis Case Study: Trader Buys Baseball's Red Sox...Who Says You Can't Get Rich Trading?

By Dr. Steve Sjuggerud, Chairman, Investment U

Tuesday, October 21, 2003: Issue #283

18 months ago, trader John Henry bought the Red Sox for $700 million. Before that he owned the Florida Marlins. And a stake in the Yankees.

One of the old jokes is that you can't get rich trading. I guess John Henry never heard that one

Henry made his fortune in the markets - trading trends. He looks for trends and rides them - he's probably made a lot of people rich along the way $10,000 invested in his oldest portfolio (started 20 years ago this month) would be worth an astounding $1,394,610 today for a 13,846% return - or 29.68% a year.

From time to time, people ask me about trend following and technical analysis does it really work? How? And where can I go to learn more? Today we'll answer those questions with a technical analysis case study, and perhaps start you on your way to John Henry-sized wealth

Technical Analysis Case Study: John Henry Is All the Proof You Need

Technical analysis (and by extension, trend following) is the study of price action at its core. Said another way, it's ignoring everything, except for the price.

'Anything that could possibly affect the market price of a commodity or financial instrument - including fundamental, political, or psychological factors - will be reflected in the price over time,' John Henry says. In other words he believes the P/E ratio doesn't matter deficits don't matter, a Republican in the White House, wars, etc. It all doesn't matter. Or more correctly, it's already reflected in the price.

Interestingly, in the case of John Henry, he?doesn't try to predict trends. Specifically, on his web site (www.jwh.com), he says:

'What we don't try to do is predict trends. While confirmation of a trend's existence is sought through a variety of statistical measures, no one can know a trend's beginning or end until it becomes a matter of historical record We cannot expect to enter a market at the precise moment a bottom is hit, nor will we exit a market at the exact top.'

What Works In Technical Analysis and Trend Following

To get to the bottom of what works, we can look to this quote by John Henry from TurtleTrader.com:

'There is no Holy Grail [We] only pay attention to what the markets are saying currently, and don't ask why the dollar is going up or why interest rates are going down. Our philosophy is that if something is going down, we want to be short. Period.'

As Henry said, there is no Holy Grail of what works. So the best way to approach this might be to say what doesn't work. According to TurtleTrader.com, there are many approaches that 'the world's best Trend Followers avoid within their trading systems.' These include:

  • %R Oscillator
  • Astrology
  • Candlesticks
  • Cycle Prediction
  • Delta Moon Prediction Techniques
  • Elliott Wave
  • Fibonacci
  • Fuzzy Logic
  • Gann
  • Genetic Algorithm
  • Geometric Angles
  • Golden Spiral
  • Granville's On-Balance Volume
  • Island Reversals
  • Moon Phases
  • Neural Networks
  • Planetary Motion
  • Point and Figure Charts
  • Relative Strength Index
  • Seasonality
  • Support/Resistance
  • Weather
  • Proper Thinking About Entry/Exit

TurtleTrader.com also talks about trading 'patterns,' and says that 'Top trend following traders do not use these patterns in trading:'

  • Reversal Patterns
  • Continuation Patterns
  • Head and Shoulders
  • Symmetrical Triangles
  • Inverse Head and Shoulders
  • Ascending Triangles
  • Triple Tops
  • Descending Triangles
  • Triple Bottoms
  • Double Tops
  • Double Bottoms

Me? From all of the above, I don't know what works, but I haven't spent much time trying to figure it out. TurtleTrader seems to have spent some time with their own case studies, and says that 'trend following' traders in particular don't use any of them.

For me, the jury is still out on most technical analysis in general. However, I do think that there is some validity to trend following systems in particular. There are just too many John Henrys out there for it to be an accident. In my own 1-2-3 Stock Market Model, one of the three elements is a simple moving average - a trend following indicator of price action that has been exceptionally good over long periods of time.

To know exactly where I stand on technical analysis, I highly recommend you go back and re-read Investment U e-Letter #142: Stock Technical Analysis: Holy Grail Or Sham? What Works in Technical Analysis and How To Use It To Improve Your Investing. After you've read that, I think you'll understand why I follow these ground rules for investing or trading success

  • # 1. Know as much as possible about what you're doing BEFORE you invest any money. Don't invest as you learn chances are, you'll end up losing as you learn.

 

  • # 2. Read a few good books, like Martin Pring's Technical Analysis Explained, Van Tharp's Trade Your Way to Financial Freedom, and Tim Hayes's The Research Driven Investor before you invest a penny.

 

  • # 3. Spend weeks studying and paper-trading a system before trading it with real money.

Basically, don't trade until you are absolutely, 100% confident that you are ready for any and every situation.

It is possible you may be able to come up with a moneymaking trend-following system. But chances are (like everything else in life), you can't buy it off an infomercial on TV. It will be hard work. It will be time-consuming, slow, boring and hopefully personally rewarding. But it still may not make any money.

Hard work on your system doesn't guarantee you success. But there sure are plenty of John Henrys out there, and today's case study on technical analysis?proves it people rich enough to buy up storied sports franchises, so extraordinary success is surely possible for some including you.

Good investing,

Steve

Today's Investment U Cribsheet

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