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PAINTING the TAPE Article ... by Stephen Rappaport

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Georgia Bard  Grandfathered Member Thursday, 10/26/00 09:31:44 PM
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PAINTING the TAPE Article ... by Stephen Rappaport

Analysts Do It, Traders Do It, Even Educated Individual Investors Do It!
Why Technical Analysis Is the Security Analysis of the Future

There was a time when technical analysis was akin to tea leaf reading. Fundamental analysts scoffed at the idea that you could determine the future direction and trend of stock prices by looking at past price patterns. Those days have changed. The investment world is being revolutionized by a new phenomena, the emergence of the individual investor and technical analysis is a big part of that revolution.

First things first, what is technical analysis? In its simplest form, technical analysis is the study of past price patterns. Technical analysts believe that certain price patterns repeat over time. Understanding and identifying these price patterns should lead to many profitable trading opportunities. That is the theory.

In practice technical analysis is all about understanding supply and demand. After all, a stock price is little more than a graphic illustration of the relationship between supply and demand. For example, when a stock is well liked demand for that stock will generally out strip supply. The result should be a big run-up in price. There is an indirect relationship between price and the willingness of investors to chase the stock. Demand slows yet supply remains constant and prices fall. This "cycle" has been played-out since the beginning of time, price is all about supply and demand. Technical analysis is the study of supply and demand.

In recent years Wall Street has warmed to the idea of technical analysis. All of the major and regional brokerage firms have well funded technical analysis departments. Indeed, most of the talking heads for the major Wall Street firms, that is, those that appear in the media regularly are technical analysts. For example, Prudential Securities' Ralph Accampora and Merrill Lynch's Walter Murphy are noted technical analysts.

How did this happen? To a large extent Wall Street was forced to become more in tune with technical analysis because of the advent of futures. Well before the stock market crash of 1987, futures trading began to played an increasingly large role in the day-to-day and week-to-week direction of stocks. By definition futures traders are speculators and are very concerned about short term fluctuations in supply and demand. With few exceptions, major futures traders use technical analysis to determine trading opportunities. Often when these traders are interviewed on CNBC you will hear them talking about price action and supply and demand, not the underlying fundamentals.

Okay, Wall Street does it, professional futures traders do it ? but the most important development over the past three years is the proliferation of individual investors using technical analysis. In fact, modern "day trading" is based on the notion that certain technical patterns yielding low risk trading opportunities occur several times per day. Day traders attempt to capitalize on these opportunities using technical analysis.

If you visit the most popular investing web sites you will find the message boards littered with talk of head and shoulder tops, stochastic buy signals and MACD roll-overs. To be sure, much of the move to technical analysis can be attributed to the information technology revolution. As corporations have invested more funds in their Internet web sites, the individual investor has become empowered. Many web sites offer rich technical analysis content that had previously been available only to large institutional investors.

But that is only half of the story. Today individual investors can buy software programs that very accurately target proven technical price patterns and characteristics. The market for this type of technical analysis software is exploding as more investors take charge of their financial futures and begin trading their own accounts via on-line brokers. Wall Street can no longer ignore the importance of this new generation of "traders".

That is the good news. The bad news is the emergence of technical analysis means that far more often once proven technical price patterns fail. Trading is a zero sum game, that is, for every trader that wins, another trader must lose. Typically, the winning traders are seasoned veterans. They know exactly what stocks are being touted by investing web sites and what stocks are highly rated by technical analysis software programs. In fact, professionals will often "paint the tape" to skew the odds in their favor. Painting the tape is the technical name for the process of building bull and bear traps. These traps are designed to make unsophisticated investors believe a new trend has developed when in fact, the old trend remains valid. Unsuspecting investors will rush to add positions only to see the stock price quickly reverse. This practice causes wild volatility.

Is the emergence of technical analysis for individuals a good or bad thing? Any time individual investors are placed on the same footing as professionals it is a good thing. Successful investing is about gathering information. To make informed decisions individual investors need to be aware that technical analysis plays a large role in the stock market but they must also be aware that "trading" is a zero sum game. To trade with professionals it is important to learn how to identify real and false technical signals. Understanding the basics of technical analysis is not enough. Education is key. - by Stephen Rappaport

:=) Gary Swancey
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