Page 417 - THE MARKET WHISPERER

THE MARKET WHISPERER 41 3

Noise Cancelling

With due respect to classic technical analysis, stocks do not need to behave
“by the book.” Most of the money in the market belongs to the long-term
investors, to funds, and of course to a group of Warren Buffet-type folk.
They do not always check the chart before they buy a stock. Did the stock
breakdown in the perfect “head and shoulders” formation? Why on earth
would that interest them!? They may be buying right when you sell, for
entirely different reasons. Technical analysis does have its limitations. In
fact, I can assure you that if you operate according to perfect technical
rules, you will end up losing.

Technical analysis states that the uptrend is defined as a succession
of higher highs and higher lows. Let’s say you bought a stock currently
trending up, and its price has now dropped to a new low. Would you sell
it at precisely the point where it drops under the last low? Technically
speaking, yes; but in reality, no.

It is most likely that everything you have experienced during the price’s
drop under the last low is nothing more than “noise”. It could be that you are
seeing the first signs of a direction change, but in many cases it is nothing
more than a temporary pullback caused by someone selling thousands
of shares without checking the chart. At the start of my trading career, I
would set the stop order one cent under the last low. I would forget that
the stock owes me nothing: neither behavior according to the technical
analysis, nor according to the price I bought at. The reason it may drop
several cents under the last low can be very simple: someone might have
sold 1000 shares with a market order, which drops the price by several
cents under the last low. Does every small change in price draw you out of
the game? Sometimes, yes; generally, no.

Noise in stocks is also one of the reasons why I try to avoid, as far as
possible, using hard stop orders. Stock prices constantly show spikes in
either direction. To understand the stock’s general direction, we need
to relate to its overall framework of movement rather than chance price
volatility, since the latter may cause you to imagine all kinds of unrealistic
statuses. I am not saying that in such cases you should bury your heads
in the sand. You do need to be cautious, and remain ready for a change