Frodes, FI 334 pay tore Fable of Contents 4 1 1 Market Street by Dave Jennings August 10, 2003 "Everybody gets what they want" —Ed Seykota Issue #111 Listen to what the market is saying about others, not what others are saying about the market. - Richard D. Wyckoff, early pioneer in the field of technical analysis Wyckoff Said It First (and the best) Wyckoff's Investment Theory Conception of Primary Phases Accumulation: The establishment of an investment or speculative position by professional interests in anticipation of an advance in price. Markup: A sustained upward price movement. Distribution: The elimination of a long investment or speculative position. Markdown: A sustained downward price movement. Wyckoff believed that the action of the market itself was all that was needed for ent, scientific trading and investing. The ticker tape revealed price, volume and time relationships that were advantageously captured by charts. Comparing waves of buying and seiling on the bar chart reveals the growing strength of demand or supply. With the aid of schematics of accumulation or distribution, the speculator is able to make informed decisions about the present position and probable future trend of a market. The figure chart is added to project the probable extent of a price movement. Wyckoff also revealed how to interpret the intentions of the major interests that shape the destiny of stocks and how to follow in the . footsteps of these sponsors at the culmination of bullish or bearish trading ranges. nto OLD Page Ff 10 ‘Sealants mC WAUARE Ta Anan on Abn 28 eranSource: yyww.hanko encom Q&A with Dr. Henry O. (Hank) Pruden A gentleman, a scholar and a trader for his own account, Hank Pruden returned to his California roots and the world of academia more than 20 years ago as a professor of business at Golden Gate University. Dr. Pruden's fascination for the investment theories of Richard D. Wyckoff spearheaded an effort that eventually culminated in a series of accredited courses on the subject of technical analysis of securities. Dr. Pruden supplied some of the background on Wyckoff and the subject of trading in an August 7 interview. Q: An article in the summer edition of the Technical Securities Analysts Association of San Francisco, of which you serve as president, is based on the investment theories of Richard D. Wyckoff. Gan you provide a synopsis? A: If | can recall, Wyckoff has a number of principles. That said, could we pull those all together and reduce them into some sort of systematic form? And indeed, Wyckoff people have done that with their nine buying tests and nine selling tests. They are the accumulation of some classic principles. That's a nice place to have a checklist as a guide for analyzing accumulation bases and distribution tops. Those nine tests are part of what is described in the article for accumulation purposes. That is the old, classical approach. What is left in confusion, though, is when we enter periods of consolidation after a market advance. At that time, there are many earmarks that one would find in distribution in the early phases of the accumulation zone. Hence, the classic buy tests don't apply, or dont fit perfectly to that. What that knowledge in mind and the frustration built around that, | attempted to offer nine new tests for re- accumulation that would be modified to reflect the fact that it is not after a decline that one starts to see factors that show an accumulation but after an advance. Then you go into re-accumulation and you would have factors that would prevent you from confusing that with distribution, So, the notion would be that we would have nine tests for accumulation, nine tests for re-accumulation, nine tests for distribution, and | have yet to be specific, nine tests for re-distribution, which are the consolidation periods during a bear market, That is the essence of the article - recapping the classic - offering something new. : The readers aren't aware that for many years you have been a professor at Golden State University and that you teach a course in technical analysis. How many years have you taught it? ‘A: What had happened is | had been in the Chicago region, leaving academe to trade for my own account, which | did so for a period of about 20 years. | retumed to the San Francisco region. My family is from here. We had small children. That was one reason. The other one was | wanted to select a city that had a financial market of some strength in it. So | came back to San Francisco and lo and behold | discovered that there was a technical society here. That sort of did it for me. | moved my family out here. But | have always been an academic. | continued on a part time basis offering the first ever course in technical analysis at Golden Gate. The dean was very open-minded. He was a market driven sort of person. He said, "Look. | trust that you know what you're doing. You've got good credentials. I don't know about this subject area that you're going to teach, but technical analysis sounds interesting. Ill let my students be the judge. If they continue to take it and pay the fees for it, that says its going to be okay for me. So I'll give you a chance to run.” [PM pugta anne alts APAREF air At olin An ron Vette e120| offered the first ever technical analysis class in the fall of 1976. There weren't many texts around, so at that time | used a book by Jerry Apel called Winning Market Systems. Q: He is a famous technician. \: Yes, he is. Jemry Apel has made a lot of creative contributions to the technical field. He is probably best known for MACD. He made many other contributions. Well, out of that grew a number of students coming from the financial community wishing to further their knowledge in technical analysis. One thing grew to another. Students kept coming back. They wanted more. It was sort of divide and conquer. One Course grew into another. A lot of experimentation came about. About a decade later, we started having an introductory course, a survey class, and intermediate-level courses. What turned out the best package was Wyckoff. And, then some advanced capstone course. Those often focus on trader psychology. That is the curriculum that has evolved over time through trial and error as a collaborative effort of the people in the technical community, principally in San Francisco. Q: It says on your Website that the technical analysts society in that city is the oldest in the country. A: Yes. That is an interesting coincidence. The two societies, the one in New York, the Market Technicians Association and the Technical Securities Analysts Association in San Francisco were both formally created in the early 70s. The founding of the San Francisco society occurred a few months. before the one in New York. Q: How many members belong to the society? A: Last count it was about 140 members. That number tends to swing up and down depending on the economic cycle and the direction of the market and also during the year. | am currently president and this is my second time at the helm. Q: | noticed the society publishes a newsletter. | assume the majority of the membership is comprised of dues paying professionals. A: There is a range. We certainly have the doors thrown open to those who are aspiring to the lear something about the field and might be dubbed as amateurs. Then we have those who are pretty seasoned professionals. We don't discriminate. We're open territory out here. We invite people who are really interested in the field to join, to leam, intend to contribute and to grow. We happily have some case histories of people not knowing a great deal that join the society, take classes at Golden Gate University and emerge a year later as quite competent technicians with good success records. Q: Do many move on and apply those skills in their professional careers? A: Yes, Ranging from doing research and analysis to, say, money management or financial planning Many of them are involved for managing their own affairs or trading for their own accounts. Q; It has been said that the field of technical analysis is as much art as it science. However, in my view, the same could be said of someone that takes the strictly fundamental approach in an attempt to predict the future price of the shares of a company based on a thorough research of its financial condition and the industry in which it competes. That also produces varying degrees of success. | might feel safer predicting on the Wm. Wrigley Company, the world’s 342 rane Verh POLO ote 30010largest chewing gum maker. But | would have a tougher time with a developmental stage biotechnology company. | tend to view technicians as trying to remain detached from this. How do the courses you teach deal with this issue? : A: Because one is at a university, there is a division of labor whereby other courses are taught on investments or portfolio management. There is some separation. From the students’ point of view, the student can put it together so that the burden doesn't fall on one person's shoulders to cover everything With respect to fundamentals versus technicals, | think that is always a healthy debate. Though | think there probably is another way of framing it where you can find that is really a complement and supplement. There is the notion of the so-called capital asset pricing model. In it there is this notion that retums are a function of risk, but the risks are of two types: the unique risk to each corporation and the overall market risk. The fundamentalists try to judge the value of firms, which is the unique risk of each company. By saying if we have a basketful of companies that are different from each other and diversify, we'll handle risk Well, | think they go to sleep at the switch at the end of that equation because as we recently experienced in the big tumble of 2000 and 2002, the whole market got swept downward. Asset allocation across companies is not sufficient. There is a big market risk element. That market risk element, as you mentioned earlier, money management is one tool to avoid getting smashed. The other one is some sort of a judgment to handling that market risk. Fundamental analysis is no good or limited for handling market risk. The big enchilada in handling market risk — and that is the next big additional contribution — thas to come through some other kind of approach. | think technical analysis is one of the best for timing and the handling of market risk. Even though it might not be sophisticated, it touches on a really important area. So, any values there are really large values added in terms of being able to control one's portfolio. during up and down major market moves. Q: One aspect of Richard Wyckoff that fascinates me, after having read his biography and another book that was an extension of the magazine he published during the first 25 years of the last century, is how he evolved in his approach to the market. He shifted from a strictly fundamental approach to an understanding of how large market operators have a major influence on the movement of stock prices. The large interests of his day were wealthy individuals. Today, these pools of large money interests are controlled by mutual funds, pension funds and bank trusts. Yet little has changed. They still leave their footprints on the charts. When Wyckoff came to that conclusion, as far as | can tell, he never wavered throughout the remainder of his career. Do you share that view? A: | would certainly agree with your summary of his history. What I most appreciate most about Wyckoff is his insights in terms of the interaction of the various players in the market. In other words, there is an equation between buyers and sellers. And i's a very useful device. | don't know whether its 100% documented, but it's a very useful device. | think the fancy term for it might be that of a heuristic. That is an assumption that the markets essentially are run by and for the benefit of the so-called composite operator. We're assuming the market is being reflective, | would say, of superior, intelligent, wealthier and stronger hands, whomever they might be, at any time. That is a very, very helpful insight. Then, you can attach to that the phases of accumulation, markup, distribution, markdown in the intentions of the composite operator in each one of those stages. To give a person a better picture as to what might be happening - it all sounds pretty abstract - a close companion piece to Wyckoff was something also written during the same epoch, Reminiscences of a Stock Operator. If you read Reminiscences, which | did many years ago, you say, "My God, that's fascinating. | wish somebody would codify in some understandable fashion all the essential ideas of what is contained in Reminiscences of a Stock Operator.” ‘os ntseinCAPARES a Aaah Veen Atti ert persion in FTL Page tofLo and behold, | think that is essentially what Richard D. Wyckoff did. So Wyckoff and the Wyckoff Method and Lefevre's Reminiscences are two ways of looking at the same story. There are rich pieces like James R. Keane bringing U.S. Steel into the market and what he did then. Then you read Wyckoffs principles and you say, "Wow, these things really mix and match very well.” Q: The two men were contemporaries. In Wall Street Ventures and Adventures Through Forty Years, Wyckoff mentioned that he interviewed Jesse Livermore [William Lefevre] for his publication, The Magazine of Wall Street. A: Yes they were. Both published. They both wrote. The Street wasn't as large then as it is today. Q: As you say, Wyckoff codified how Livermore operated. A: Right. He captured the best practices of the day. The best practices came from the accumulated experience and wisdom of those who were actually operating in the markets. They probably didn't reflect so much on what they were doing or why and the consequences of it; whereas, | think Wyckoff had some exceptionally keen observational skills. Also, being a good journalist, he could document them. He was participating. In fact, there is a lot to be said about Wyckoff himself, because a lot of other people were experiencing the same things. You and | could perhaps have been there at the time and not have had the keen insight and sensitivity to what was going on around his world that Richard D. Wyckoff did Q: That is the gist of how | grasped what the man was up to. He also managed to become wealthy from the market. A: He did very well for himseff, both, | think, from his investments and even more, | guess, through his publication business. He had a very wide and strong following as a consequence of his market letter. As an aside, you mentioned Jesse Livermore. There is a small monograph that is in print that contains an interview Richard Wyckoff conducted with Jesse Livermore. | think it was in the 1920s, but it could have been in the 1930s. Livermore was probably larger than life even back then. | think a lot of the behaviors of other people - being smart money, using tips, spreading rumors, knowing that you need to get the market, moving, to get the floor traders on the board first thing off - those were things attributed to Livermore. But | think they were all common knowledge practiced by the astute traders of that time. Q: One thing | repeat in the newsletter | write is, "There "ain't nothing new under the moon, sun and the stars." Although I no longer watch it, one of the floor journalists for CNBC constantly talks about rumors circulating through the trading desks and how they had an influence on stock prices. It seems to me the same techniques that traders use today were used more than a hundred years ago. ‘A: Yes. What | like about that, given the presence of those rumors and what they mean and possibly don't mean, there are stories told in Reminiscences of a Stock Operator where a tip is given to an operator and he doesn't take the tip. He goes into the market and he tests it. If somebody said, "Havermeyer is buying and sugar is going up,” he sells sugar in the market and sees how well it is absorbed. If it is absorbed, then he turns around and loads up his boat. You'll find the same thing reflected in Wyckoffs work. The Wyckoff Method is almost like a two-step. In other words, action, test; action, test; action, test. You get a breakout, well, yes; lets see what happens now on the retest of the pullback from it. You get a thrust to new lows; lets see what happens on the subsequent rally. All of those things like action, test are the same sort of notion we find in Reminiscences where the smart money is testing the market, finding out the validity of whatever seems to be driving it, whether it be rumor, news or just a general collective action. serait dr 710120 we S06 10Q: | also point out that the people that do this "testing," as you say, | refer to as the smart money. The bigger operators are able to do this because they have access to greater sources of capital and are savvy enough not to allow themselves to get caught in situations like short squeezes or where they eventually exhaust their capital so they cannot further test the market. The individual doesn't have this capability due to a limited access to capital. In my view, it pays to be patient and just observe for the classic signals before making significant commitments with one’s capital. A: There is one big hurdle that one must appreciate such as using the Wyckoff Method and attempting to do that. Right from the outset, | should declare that this is a judgmental system, not a mechanical system. You're not going to take Wyckoff and create a computer program for it and have it automatically do the work for you. Q: In my view, that would be impossible. A: This is more of you're asking it to be like Sherlock Holmes who sees a clue here, a clue there, has the experience, knows the pattem, knows what to do next to get the next piece of evidence, and as that pattern evolves, starts to take action. Certainly if you could reduce that into a nice formula, one would love it. An expert user system that generated all the information for you that would make life easier. But it is a fact that the world cant be reduced so simply. Wyckoff gives you some guidelines, some perspectives, and also suggests that you have a good deal of trading experience, either practice trading or real trading to get the real feel for it, to get comfortable, in using the technique, because it is judgmental. It has not easily adapted. One has to spend time and effort and practice, practice, practice to get the skill level where you really feel comfortable and competent in applying something like the Wyckoff Method. Q: That mention of a formula begs a question within me. You're an academician at a university and have access to people with extremely high levels of computer skills. Has anyone ever approached you about developing a computer driven model that can be back tested? A: That probably happens about two times a year. That is often something very appealing to someone, say, with an engineering background. Particularly in an environment like San Francisco, there are a lot of real bright technical types here. What is interesting to see are those that engage in Wyckoff emerge with an appreciation and say, "Hmmmtgee, the market is a different animal. It isn't quite like electrical currents and metals." Often, there is a leaming process that occurs. The engineer or scientist gets frustrated trying to make the damn thing repeat and act correctly. They say, "My God, I'm building a brick wall.” They come to realize to that they have to appreciate the nature of the beast rather than trying to make it fit into a mechanical paradigm. Often times, | find it's a learning process for those who attempt, lets say, to rationalize it. But, nonetheless, in the process of doing so, they apply some discipline and they emerge out of this pretty darned, savy Wyckoff students. Q: Really all you need in applying the Wyckoff Method are the bar and volume charts and the point and figure that does, as | understand it, attempt to predict the magnitude of a move, up or down. A: That is accurately said. The point and figure chart is much like a special teams player. It has its particular function and that is to me the accumulation or distribution or re-accumulation or re-distribution that occur. There is a set of rules for interpreting them and they're done so for anticipating what potential eb gabe ni CH AFARGF Dah Aaa in irra é-PIDL0 Page 60f 10there might be in the market. That is exceedingly useful for reward-risk appraisals in money management. A good base in which you can use more liberal stops. Probabilities of how far things are going to go. You're on the alert when you reach into that range for possible exit points. it's a useful supplement. I've discovered, though, that people don't grasp it. I's simple, initially. But to get the skill evel of dealing with the point and figure is not as simple as | thought it would be. Our Wyckoff course here is Wyckoff | and Wyckoff I. In the fall term itis principally supply and demand using bar charts. Then in the spring, we continue that but then focus on the point and figure. We tried to do it all in one 15-week term and found we were bursting at the seams. It was just too much. We saw that some very astute people were having some difficulty in honing their skills with point and figure. So we found that we needed to take that on in a separate term, Q: I would have to agree. One thing that | have found in my personal experience is that | commit the same error of many participants in that we tend to trade too much and fail to stick with situations long enough. We don't stay with the trend. The trailing stop Is the major weapon to counteract the emotions of fear and greed. A: That is certainly one useful tool about the notion of the judicious use of stops. But that raises a point that Wyckoff himself had made. He said, "Look, this methodology I'm presenting to you is only 50% of the battle, 50% of the game. The other 50% of the game is what is going on in your own head and your own heart.” And that is the necessity of having a discipline, of being aware of who you are and what you are doing. It is almost like a progression. One gets the basic fundamentals. One then engages in something more advanced like pattern recognition. Although with Wyckoff, by the time you get those things down, you say, "Damn, I've got another issue to deal with and that is | need some pilot training." And there goes the third level, which is that of mental discipline, or trader psychology. Over the last decade, there has been a lot good stuff done in that area. Q: I would describe it as a situation that involves self-mastery. By mastering yourself first, you make the market your servant. A: One might ask, "Well, why doesn't one start with that?" Because that is very, very difficult to do. Q: | would agree. You can't begin mastering yourself until you've made some mistakes that help you to learn what is inside yourself. A: Yes. And having some sort of methodology. ! would say outside of the United States Marine Corps, where you remake the man first and then show him the skills second, most of life doesn't have that sort of total, enclosed, separated environment. Trading boot camps that say, "Lets change the psychology,” are probably a little overstated and a little overly ambitious, because you don't have the context. Most people need some sort of methodology first. Once they have that, then their minds will be open to work on themselves and to get some psychology and mental discipline, There are tools and techniques of doing that. That has been my observational experience. One does need some grounding, some ideas of how the market works before working on themselves. Q: That takes us to the field of behavioral finance, which, | guess, is a fancy term for trader psychology or investor psychology. A: | think behavioral finance is more comprehensive than that. For years, there was the assumption made in the finance area that we were all economic men. And economic men that are totally rational, totally informed - yet totally nonexistent. In other words, that is an assumption that can't be supported byhuman behavior. But as we get into human behavior, there are things that we do individually, how | feel and so forth and just who | am. But there is also a good deal of how | am influenced by other people Which is sort of the herd mentality. The feedback from the market is an absolutely beautiful example of that. So | think that behavioral finance gives us ideas, ways of looking at the world, piecing things together, on collective behavior. Lets call this the mass or crowd psychology of the market. There are thoughts there. Taken from the social sciences, there is gravitation toward the use of models. There is a model for understanding how the markets work. One that I've found very useful and that | have applied is the life cycle model for crowd behavior. Then you go into the individual psychology, whims, and shortcomings. All the mental discipline work sort of falls in there. A third piece of it might be considered as that of market sentiment. Which of these are indicators, or ratios, or relationships that we're trying to judge about the sentiment of the market. That, too, can'be placed under the heading of behavioral finance. My thinking is that it is most useful in the modeling area of crowd behavior on the one hand and also the insights that it can give us in terms of our own shortcomings or failings, either cognitively or our emotions and what we might do to compensate for that. | think i's a very rich addition to the study of technical analysis Q: The 1999 market was one of crowd behavior to the extreme. What is fascinating is to see how the herd reacted as the chart made its way down the other side of the mountain. The chart reflects the collective decisions of people over the course of time. A: Itwas nice of you to mention that, because there have been some fascinating studies of past markets. The most recent, Devil Take the Hindmost by Chancellor, those case studies in it say, "My goodness sake, everyone of them has the same patterns, the same characteristics that occur time and again.” You see this with the general public. He's going to quit his job, tell the boss to take it and shove it and he's going to live the life of Riley day trading the market. We've found the equivalent from Tulip Mania to the South Sea Bubble to the Sixties to the present. So, markets tend to reflect basic recurring pattems. A person like Wyckoff gives us a way to decipher, make some sense of and how to interpret those recurring pattems. It gives us a rationale with the smart money composite operator as to how perhaps why we should have confidence in our readings. | think that Wyckoff*if you're stuck on the desert island and someone said you can have one technical methodology and that's it. | think for my money it would be Richard D. Wyckoff. Q: What that tells me is that being an academic, you have to keep an open mind and have studied other methodologies and back tested them with the computers at the university. A: Oh, yes. | was the editor of the Market Technician’s Association journal for eleven years. It gave me an opportunity to see a tremendous variety of different studies that were made, most of which were quantifications of market behavior of one sort or another. I've had plenty of opportunity to see them. But I've also had the opportunity to see what people are capable of doing. Those who have taken something like Wyckoff and have adapted it to something like options trading to major long-term portfolio management to foreign exchange to fixed income to equities in the U.S. and abroad, and | say, "What a fine, versatile system." Sure, it takes time, dedication and practice, but it certainly is good and sound. It might not be the most sophisticated system. | wouldn't brag that it would be. But, amongst those that are available itis a very sound, feet-on-the-ground kind of approach. If one had to make a forced choice with what we know today, that, to my mind, would be the winner. That doesn't mean that we dont continue to evolve it and improve others and perhaps something else will supersede it. But at this fime and juncture, | certainly salute the works and methodology of Richard D. Wyckoff. Q: That leads us to good conclusion or stopping point.- Ar 1, too, need to bring things to a conclusion because | have some clients to advise. It's that time of year. ‘So why don't we get right down to the remaining questions that you might have and I'll attempt to handle those in the next five or ten minutes. Q: Since you're going to advise someone, you say on the website that you offer short, one-on- one courses with people that are wiling to spend the time. It means to me that you have the patience to spend hours at a time with one person. A: Ive found some of those have been very fruitful. What had happened over the years is that people from outside the Bay Area would request to leam more about Wyckoff, or they wanted to build some skills on behavioral finance. Then suddenly one young man came in from Holland who was sponsored by his bank. | created a tutorial especially for him. He had an American family he knew from college days that he lived with. We had a tremendously successful two-day session. Really accomplished a lot. From the basis of that, | started offering other tutorials, either one-to-one, or you could tailor things for the individual and engage in interactions in working together. I've gone as much as four days with some individuals. So that is one way to supplement what is available in San Francisco for those who are from out of town. That, too, is something that | do. And | grant an informal, non-degree certificate for that experience. Q: That person will certainly earn his degree in the real world. A: Yes. Ultimately, that is going to be the arbiter of final judgment. The market will make the ultimate assessment. 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